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Growing recognition of ‘real estate’ cuts firms’ tax bills

Companies with short-lived real estate will save $600 million on their taxes by incorporating as real estate investment trusts.

Globe photo/file

Companies with short-lived real estate such as Iron Mountain will save $600 million on their taxes by incorporating as real estate investment trusts.

To the untrained eye, the steel racks Iron Mountain uses to store documents and electronic records look like the shelves in any old warehouse.

But as the Internal Revenue Service sees it, those racks are actually real estate, just like an office building or a parcel of land. The tax agency ruled in June that the Boston company can reorganize as a real estate investment trust, or REIT, providing a tax savings of $130 million to $150 million annually.

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Iron Mountain’s move is part of a trend that has seen the number of publicly traded REITs rise more than 50 percent to 209 from 136 in 2008, according to the National Association of REITs. In addition to the tax savings for the company, those stocks have become popular on Wall Street for their healthy dividends.

In recent years, the IRS has said crops on agricultural land, an off-shore oil platform, gas pipelines, billboards, and the powerful electrical and air conditioning systems used by Internet data centers all qualify as “real property,” making their owners eligible to form real estate trusts and cut their tax bills. In 2011, the most recent year for which data is available, there were nearly 1,700 private REITs, in addition to those traded in stock markets.

“Fifty years ago, when we talked about real estate, we talked about office buildings and the elevators inside of them,” said Martin Sullivan, the chief economist at Tax Analysts, a Virginia publisher of tax news and commentary. Today “all bets are off. There is no dividing line between real estate and anything else.”

A private corrections company became a REIT last year on the grounds its prison cells were real property and that its armed guards provided a service for its “government tenants,” similar to a doorman serving the residents of an apartment tower. The year before, Penn National Gaming created a REIT to own 17 of its 26 casinos and racetracks, and now its real estate entity is more valuable on Wall Street than Penn itself.

Penn officials could not be reached for comment Friday.

REITs have become particularly popular during the economic recovery as investors gyrate toward stocks that pay high dividends. Under federal law, REITs are required to distribute 90 percent of their profits to stockholders, which helps them reduce or eliminate their tax liability.

“Because of the recession and the desire for steady yield, REITs all of a sudden have become hot,” said Kelly Kogan, a tax attorney and REIT specialist. “You have everyone and their mother saying, ‘OK, I wanna be a REIT.’”

Last month when Iron Mountain announced its long-sought REIT conversion would happen, the company’s stock jumped 17 percent. And in 2012, the GEO Group, the country’s second-largest operator of private prisons, distributed $350 million to shareholders as part of changing to a REIT.

There are barriers and disadvantages to becoming a REIT. It is time-consuming and costly for the company. Moreover, REITS have to operate under rules that may be too restrictive or cumbersome for some companies, and the dividend payouts limit the profits companies can reinvest.

But a Republican leader in the House of Representatives wants to block the rush to form REITs. With the surge in real estate trusts costing the US government billions in lost tax payments, Representative Dave Camp of Michigan, who chairs the House Ways and Means Committee, has drafted a massive tax reform bill that would reverse past IRS rulings and outlaw many REIT conversions.

“The REIT rules were not intended to facilitate erosion of the corporate tax base,” the Ways and Means Committee said in a document accompanying a draft of the tax proposal.

By law, REITs must generate three-fourths of their income from real estate. And in addition to land and buildings, the IRS has said that real property can include “inherently permanent structures” and their “structural components.”

By that definition, then, the IRS has said “steel racking structures” Iron Mountain uses to store its customers’ records, the framing that attaches billboards to buildings, trees used in timber harvest, and towers used to hold cellphone antennas all qualify as real property.

The IRS declined requests for comment. In 2012, the tax agency told the Wall Street Journal that “sometimes newly developed assets” meet the definition of real estate, and approving those REIT conversions “should not be confused with a relaxation of the standards themselves.”

But Camp’s legislation would limit the types of assets that would qualify as real estate. Some legal specialists have suggested that cellphone towers would be disqualified, which may affect another Boston-based REIT, American Tower Corp. That company became a REIT in 2012.

American Tower declined to comment.

The proposal would also explicitly exclude trees used in timber harvests from real property. Weyerhaeuser Co., one of the nation’s largest owners of timberland and makers of wood and paper products, became a REIT in 2010. Weyerhaeuser declined to comment.

In a statement, Iron Mountain spokeswoman Melissa Mahoney declined to comment on the proposed legislation, but said the company sees “no controversy” in declaring its racking to be real property.

“Our steel racking structures are permanent and integral to our buildings,” said Mahoney. “The IRS agreed and they are the authority.”

It’s unclear whether Camp’s proposal, if enacted, would force Iron Mountain or other non-traditional trusts to revert back to being corporations because their property would no longer qualify as real estate. Camp’s office declined to comment, but the language in the Ways and Means proposal suggests those companies would lose their tax-free REIT status.

“That’s the dilemma of changing course midstream,” said Ed Glazer, a tax attorney at Boston law firm Goodwin Procter who has analyzed Camp’s proposal.

Glazer said Congress could either force some REITs to convert back, a hugely disruptive process, or allow those companies to retain their tax advantage, which is also problematic.

“When Congress has tried to do that in the past, that raises all kinds of fairness issues — giving some companies an advantage over other companies in that business,” Glazer said.

The Congressional Joint Committee on Taxation estimates that Camp’s restrictions on REITs would generate around $7.5 billion in tax revenue over the next 10 years.

Camp’s proposal is a long way from becoming law. Glazer expected it would undergo changes before the Ways and Means committee formally submits it as legislation.

Robert Willens, a tax and accounting specialist widely followed on Wall Street, argued that the IRS had not overreached in defining real estate, but rather simply applied those definitions to structures and technologies that didn’t exist when REITs were created in 1960.

The IRS proposed new regulations in May that would formally designate many non-traditional structures as real property, and has scheduled public hearings on those proposals in September.

Jack Newsham can be reached at jack.newsham@globe.com. Follow him on Twitter @TheNewsHam.
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