It has finally happened. In December Weyerhaeuser Co. announced that its board of directors "determined that conversion to a real estate investment trust (REIT) would best support the company's strategic direction." The most likely date for conversion of the forest products and real estate development company, which owns extensive timberland, is the taxable year ending December 31, 2010.
From what we can gather, the conversion will not be accompanied by a spin-off of Weyerhaeuser's nonqualifying assets. Instead, those non-REIT-qualified assets will be lodged in one or more subsidiaries that will operate as "taxable REIT subsidiaries" (TRSs). That said, a later spin-off, along the lines employed by Potlatch Corp. in 2008, should not be ruled out.
Once the conversion (to REIT status) becomes "old and cold," we fully expect that the stock of the TRSs will be distributed to Weyerhaeuser's shareholders. Such a distribution may be necessitated by the REIT qualification rules. Among other requirements, to remain a qualified REIT, not more than 25% of the value of the REIT's total assets may be represented by securities of TRSs. Accordingly, if the securities of the TRSs appreciate too rapidly, Weyerhaeuser's REIT status would be imperiled.
Indeed, to qualify as a REIT, the corporation must eliminate the "earnings and profits" it has accumulated in non-REIT years by the close of the first taxable year for which REIT status is desired. In Weyerhaeuser's case, the amount to be excised is nearly $6 billion. Therefore, to eliminate this balance, Weyerhaeuser must undertake distributions of property "to which Section 301 [of the tax code] applies."
As many companies have done before, Weyerhaeuser will satisfy this dividend payment obligation largely with its stock. Ordinarily, a distribution by a corporation of its stock is not a distribution of property to which Section 301 applies. However, such a distribution can easily be transformed into a qualifying distribution. To be sure, Section 305(b)(1) provides that a distribution by a corporation of its stock shall be treated as a distribution of property to which Section 301 applies if the distribution is, at the election of any of the shareholders, payable either in its stock or in property.
Accordingly, Weyerhaeuser will be declaring, probably late in 2010, a dividend in which each shareholder may elect to receive his or her entire entitlement in either money or stock, subject to a limitation on the amount of money to be distributed in the aggregate to all shareholders. Under current rules, set to expire for distributions declared with respect to a taxable year beginning after 2009, the "cash limit" can be as little as 10%.1
There is no reason to think that even if this dispensation is not extended, Weyerhaeuser's cash component will have to be higher than, say, 20%. Clearly, as a matter of law, Section 305(b)(1) contemplates that an "elective stock dividend" will be regarded as a distribution of property to which Section 301 applies, even if the aggregate cash to be conveyed is capped at a level below 10%.2
Even as a REIT, Weyerhaeuser can be subject to corporate level taxation. Under Regulation Section 1.337(d)-7, if property owned by a C corporation becomes the property of a REIT in a "conversion transaction," then "Section 1374 treatment" will apply unless the corporation elects "deemed sale treatment." Section 1374, in turn, imposes a corporate level tax on the converted corporation's "net recognized built-in gain" during the "recognition period" (the 10-year period beginning on the first day of the first taxable year for which REIT status is effective).
A recognized built-in gain is, with certain exceptions, any gain recognized on the disposition of an asset during the recognition period. Fortunately, the Internal Revenue Service has ruled that when a REIT (1) holds timber property on the date its election becomes effective and (2) during the recognition period cuts the timber and sells the resulting wood products, the income on the sale is "normal operating business income in the nature of rent or royalties," which is not subject to Section 1374.3
As a result, as long as it does not undertake any "extraordinary" sales of assets (owned on the conversion date) during the recognition period, Weyerhaeuser will not be liable for the "BIG" tax.
Posted on Mon, January 4, 2010
by Robert Willens, CFO Magazine