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PHILADELPHIA-On February 5, a day after it announced an offering of 4.35 million shares of common stock, Pennsylvania Real Estate Investment Trust discovered that it “inadvertently” had not “elected to treat” a company in which it owns a 50%-share as a “taxable REIT subsidiary,” or TRS. The law requires such designation for any company in which a REIT owns a better-than-10% share.

This is one of many “footfalls” in the numerous regulations covering REIT tax law, Les Loffman, national director of REIT services for Ernst & Young (which is not a PREIT auditor), tells GlobeSt.com. “A misstep over some item of very, very little value can cause big, big problems,” he says. “There are not many situations in which such a violation becomes public, but many in which it occurs,” he adds. Generally, the violations are quietly resolved, either by petitioning the IRS for forgiveness and correcting the reporting error, or by correcting it and paying a nominal fine.

In PREIT’s case, however, the discovery came in the wake of a planned public offering, leaving the REIT with no choice but to withdraw the offering and thus disclose its “inadvertent” failure to comply with the TRS stipulation. The company that should have been treated as a TRS is Metroplex LLC, the general partner of the entity that owns the 778,190-sf Metroplex Shopping Center in Plymouth Meeting, PA. PREIT acquired the property on Oct. 16, 2001, but it remained a general partnership for the purpose of refinancing its mortgage.

PREIT’s stake in Metroplex represents just 1/100th of 1% of PREIT’s total assets. Nevertheless, the consequences of this error in reporting are potentially devastating. If PREIT does not obtain retroactive relief from the IRS, it will owe corporate income taxes, interest, and possibly penalties on all of its taxable income for 2001, 2002, and 2003, a sum Edward Glickman, PREIT’s EVP and CFO, acknowledges the company may not have capital to cover.

Furthermore, the violation could preclude PREIT from qualifying as a REIT until 2006. Such failure to qualify, Glickman says, would cause PREIT to default under its current credit facility with Wells Fargo and others and have a “material adverse effect” on its business and financial condition.

“It would be like getting the death penalty for a parking violation,” says Loffman. During PREIT’s early morning, conference-call announcement to Wall St. analysts on Friday, Feb 6, Glickman said PREIT is in discussions with IRS representatives “at a high level,” petitioning for retroactive tax relief on the violation that “fell through the cracks” of audit procedures. While he believes relief will be granted, he acknowledges that a ruling is at the discretion of the IRS and a positive outcome cannot be assured.

Loffman agrees but believes the government will not want PREIT to fail and, for the protection of its shareholders, act quickly on PREIT’s petition. He predicts the problem will be resolved either through a fine or a reprieve that would cost PREIT nothing. Meanwhile, shares of PREIT (PEI on the NYSE), priced at $37.08 a share on Feb. 5 before the offering was withdrawn, fell to $35 a share at the close of trading on Friday, Feb. 6.

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