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April 21, 2014

IRS Work Group to Explore Definition of Real Estate for Taxation

In light of revelations such as Apple's ability to avoid many federal corporate income taxes, the IRS and the Treasury Department may be under pressure to reconsider some tax rules in order to prevent an erosion of the corporate tax base. Recently, the IRS notified information storage company Iron Mountain that it is "tentatively adverse" to its characterization of its racking storage units as real estate. Iron Mountain is seeking to convert itself from a corporation into a Real Estate Investment Trust, or REIT, to minimize its business taxation.

In fact, an Iron Mountain securities filing revealed that the IRS has created a working group that will attempt to define what constitutes real estate for the purposes of its REIT taxation purposes. One tax expert interviewed by the New York Times, however, believes the IRS is overreacting to press reports and is likely to determine that Iron Mountain's characterization is legally sound.

People unfamiliar with the tax and liability consequences of various business entities have questioned whether it is fair to tax companies that operate identically but which are different types of entities to be taxed at different rates. Shouldn’t two otherwise identical companies pay the same tax rates?

Each type of business entity does have different characteristics. Partnerships, limited liability companies and corporations can all provide similar products or services, but the tax rules for each type of business are separate. When a company reorganizes into an entity not traditionally used for commercial businesses, such as a trust, the tax rules are even more distinct.

Congress and state legislatures are ultimately responsible for determining whether those different tax rules are fair and are resulting in the expected taxation. Until they do so, however, disputes such as that between the IRS and Iron Mountain are bound to arise.

Source: The New York Times’ DealBook, “Defining Real Estate Broadly to Avoid Corporate Taxes,” Victor Fleischer, June 14, 2013

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