A small but growing number of U.S. corporations, operating in businesses as diverse as private prisons, billboards and casinos, are making a forehead-slapping move to reduce -- or even eliminate -- their federal tax bills.
They are declaring that they are not ordinary corporations at all. Instead, they say, they are something else: special trusts that are typically exempt from paying federal taxes.
The trust structure has been around for years but, until recently, it was generally used only by funds holding real estate. Now, the likes of the Corrections Corp. of America, which owns and operates 44 prisons and detention centers across the nation, have quietly gotten permission from the Internal Revenue Service to put on new corporate clothes and, as a result, save many millions on taxes.
The Corrections Corp., which is in the process of making the switch now, expects to save $70 million in 2013. Penn National Gaming, a Reading, Pa.-based company that operates 22 casinos and has been negotiating with a would-be racetrack and casino in Lawrence County, north of Pittsburgh, recently won approval to change its tax designation, too.
Changing from a standard corporation to a real estate investment trust, or REIT -- a designation signed into law by President Dwight Eisenhower -- has suddenly become a hot corporate trend. One Wall Street analyst has characterized the label as a "golden ticket" for corporations. It is often a boon for executives and stockholders, who receive generous dividends, as well.
"I've been in this business for 30 years, and I've never seen the interest in REIT conversions as high as it is today," said Robert O'Brien, the head of the real estate practice at Deloitte & Touche, the big accounting firm.
At a time when deficits and taxes loom large in Washington, some question whether the new real estate investment trusts -- or perhaps even the trusts in general -- deserve their privileged position.
When they were created in 1960, they were meant to be passive investment vehicles, like mutual funds, that buy up a broad portfolio of real estate -- whether shopping malls, warehouses, hospitals or even timberland -- and derive almost all of their income from those holdings.
But one of the bedrock principles of most real estate investment trusts -- and the reason for their tax exemption -- was that they do not do any business other than owning real estate. That has slowly changed as a result of a number of low-profile decisions by the IRS that have broadened the definition of real estate, and allowed companies to split off parts of their business that are unrelated to real estate.
The IRS released its latest decision, allowing a data and document storage company to convert, on April 5. The letter did not include the name of the company, but several data storage companies, including Iron Mountain and Equinix, are in the process of converting.
A few days later, a strategist at the Wall Street firm Jefferies wrote in a report: "It is not a far stretch to envision REITs concentrated in railroads, highways, mines, landfills, vineyards, farmland or any other 'immovable' structure that generates revenues."
The trend has been a concern to advocates of the traditional trusts, who fear that the newcomers may eventually jeopardize the tax status of older funds that do not do any business other than owning real estate.
"I worry that in a world where Congress is very sensitive to taxes, that a lot of these structures could end up attracting a lot of attention that might not be entirely positive," said Ross Smotrich, an analyst at Barclays.
Most of the activity over the last few years has involved companies asking the IRS to expand the definition of "real estate" revenue. Prison companies like the Corrections Corp. and the GEO Group, which also converted, successfully argued that the money they collect from governments for holding prisoners is essentially rent. Companies that operate cell phone towers have said that the towers themselves are real estate.
Lawyers have also been finding creative ways to follow the letter of the law by splitting off parts of a company into subsidiaries that can be taxed. In the legal world, the most controversial such effort is being undertaken by Penn National, the casino company. The company won approval from the IRS late last year to create a separate company that holds all of its real estate and collects rent from the casino operations.