WASHINGTON, DC--Well that didn't take long. There has been an uptick in companies spinning off real estate to monetize their (often struggling) operations. And while the standard by-the-book spinoffs -- recent deals done by Vornado Realty Trust, for example, or Ventas -- have not garnered a second glance by regulators, there have been some deals that apparently bothered the Internal Revenue Service.

This week the agency released new guidance cautioning companies that seek to spin off their real estate to tread carefully. It will stop pre-approving these deals, it added, as it studies the matter more closely. The concern by the agency appears to be that companies are forming REITs to avoid taxes and/or that these new companies do not have an adequate business purpose.

Traditional REIT Spinoffs

To be clear, this guidance was likely not aimed at traditional REITs, says Jahn Brodwin, a senior managing director in the Real Estate & Infrastructure Solutions practice at FTI Consulting in New York.

New property-owning REITs are well versed in how to structure themselves: it is a well-established practice with decades of law to back up the structure.

In essence there needs to be a business purpose to the spin-off besides simply to reduce future taxable income, Brodwin told GlobeSt.com. In addition, the new property-owning company has to be in an active trade or business -- not just real estate ownership for investment, he continued.

About That Non-REIT Qualifying Income

"The current REIT regulations allow for a small amount of non REIT qualifying income either directly or through a taxable REIT subsidiary," he said. It is this part of the statute that appears to be the crux of what is bothering the IRS about these deals.

The question, Brodwin said, is whether this type of ancillary non-qualifying income is sufficient to satisfy the tax free exchange regulations, specifically whether there is an active trade or business.

It is a very delicate and fine line for REITs as the statute constrains them to largely passive activities, Jim McCann, a tax partner at Kleinberg Kaplan, told GlobeSt.com. "Nevertheless, under current law this requirement may be satisfied even if each company's active assets are small relative to its non-active assets, and thus REIT and other spin offs with comparable fact patterns (such as Penn National) have proceeded," he said.

Possibilities, None Pleasant

Companies in the process of forming such a REIT, or thinking about it, can do nothing now but wait for the IRS to conclude its fact-gathering and decision making.

"It is clear that the IRS does not like these transactions, and is attempting to at least cause Corporate America to proceed with caution regarding the substance of the transaction prior to execution," Joseph Gulant, finance partner at law firm Blank Rome, told GlobeSt.com.

One possibility, he said, is that the IRS may "require companies looking to segregate their real estate operations from their operating businesses to make sure that there is a substantial active trade or business -- excluding cash, real property subject to net leases or other passive-type assets such as marketable securities -- in each of the spun-off and distributing companies immediately after the transaction."

Neil Dubnoff, senior counsel at Kleinberg Kaplan, says that the announcement of a no-ruling policy by the IRS for these situations is probably not as significant as the possibility of changes in the substantive law disallowing tax-free treatment. "One concern is that these changes could be issued with a retroactive effective date," he told GlobeSt.com.