Two classes of REIT shares with different fees will not create preferential dividends

Plain-English summary

The IRS ruled for a planned nonlisted REIT that would issue two classes of common stock with different selling commissions, distribution fees, and other class-specific expenses. The differences in distributions caused by those allocations, including potentially different performance fees calculated under the same formula, will not be treated as preferential dividends under section 562(c). The trust may therefore deduct the dividends it pays under sections 561(a) and 857, assuming it otherwise satisfies those provisions. The two-class structure also will not prevent the trust from qualifying as a REIT under section 856. The ruling does not address whether the trust otherwise qualifies as a REIT or whether its stock NAV is accurate.

Ruling snapshot

• Question: Whether different class-specific fees and expenses may produce different distributions without creating preferential dividends or disqualifying the trust as a REIT.
• Outcome: Approved, subject to the stated facts and other requirements.
• Key authorities: IRC §§ 856, 857(a)(1), 561(a), 561(b), and 562(c); Treas. Reg. § 1.562-2.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201316013 Third Party Communication: None
Release Date: 4/19/2013 Date of Communication: Not Applicable
Index Number: 856.00-00, 562.03-00
Person To Contact:
------------------------- ----------------------, ID No. ------------------
------------------------------- Telephone Number:
-------------------------------------- ----------------------
--------------------------------------- Refer Reply To:
------------------------------------ CC:FIP:B01
PLR-141373-12
Date:
January 16, 2013

Legend

Trust = --------------------------------------
-----------------------

Advisor = ---------------------------------

OP = -----------------------------------------------------------

State A = --------------

State B = --------------

State C = -------------------

City A = --------------

Date 1 = ---------------------------

a = ----------------

b = ----

c = ----

d = ----------------

e = --

f = -----------

g = ------
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h = --

i = --

j = ----

k = --

Dear ------------------:

    This responds to a letter dated September 24, 2012, submitted on behalf of

Trust. Trust requests rulings that: (1) differences in distributions on the two classes of
shares of common stock attributable to different fee and class-specific fee allocations
described below, including different performance fees determined through application of
the same performance fee formula, will not result in such distributions being treated as
preferential dividends within the meaning of section 562(c) of the Internal Revenue
Code (“Code”), and, therefore, Trust will be entitled to deduct all dividends that it pays to
its stockholders pursuant to sections 561(a) and 857, provided Trust otherwise meets
the conditions of those sections, and (2) the adoption of the two classes of common
stock with different fee and class-specific expense allocations described below will not
affect the qualification of Trust as a real estate investment trust (“REIT”) under section
856.

                                      FACTS

   Trust was organized as a State A corporation. Trust maintains its principal place

of business in City A, State B. Trust uses an annual accounting period ending
December 31 and the accrual method for maintaining its accounting books and filing its
federal income tax return. Trust represents that it intends to elect to be treated as a
REIT under section 856 for its taxable year ending December 31 of the year in which
the escrow period for its public stock offering (described below) ends.

   Trust’s sponsor is Advisor. In addition, Trust is externally managed by Advisor.

Advisor has been acquiring and managing real estate investments in the United States
on behalf of institutional investors for years and has significant experience acquiring,
managing, and exiting real property investments across all commercial real estate
property types in the United States and through multiple real estate cycles. Advisor is
one of the largest real estate investment managers globally with professionals in cities
around the world and approximately $a in assets under management as of Date 1.

   To date, Trust does not own any real property and has only nominal assets

acquired in connection with its organization. Trust represents that it intends to invest in
a diversified portfolio of high quality, income-producing, commercial real estate located
primarily throughout the United States, including, without limitation, office, industrial,
PLR-141373-12 3

retail, and multifamily properties. Trust represents further that it also intends to acquire
common and preferred stock of publicly traded REITs and other real estate companies
and debt backed principally by real estate, such as senior mortgage loans, subordinated
mortgage loans, mezzanine loans, and commercial mortgage-backed securities.

    Trust represents that it will seek geographic diversification of its property portfolio

and for the properties underlying its investments in real estate-related assets principally
in major metropolitan areas and secondary markets throughout the United States, with
up to b percent of its portfolio based on net asset value (“NAV”) allocated to properties
located outside of the United States. Trust represents that it believes that its diversified
investment strategy will allow it to achieve reasonably predictable and stable current
income, which will provide a principal source of return for investors, along with the
potential for long-term capital appreciation in its NAV. An investment in Trust’s common
stock is also intended to provide investors with exposure to a major asset class
(commercial real estate) that typically has not been correlated with the stock market,
has demonstrated less volatility than listed stocks over time, may serve as a potential
hedge against inflation and provides diversification as part of an overall investment
portfolio. Trust represents that it intends to own all of its assets through OP.

    Trust represents that it will be structured as a perpetual-life, nonlisted REIT.

Subject to regulatory approval of its filings for additional offerings, Trust will sell shares
of its common stock on a continuous basis and for an indefinite period of time. Trust's
common stock will not be listed for trading on a stock market or other trading exchange,
but it expects to provide investors with limited liquidity through a redemption plan that
will permit investors to request redemption of all or a portion of their shares on any
business day at the daily NAV per share, subject to certain limitations.

   Public Stock Offering

   Trust filed a registration statement on Form S-11 (“Prospectus”) with the

Securities and Exchange Commission to offer and sell to the public two classes of
shares of common stock, Class A shares and Class B shares. The differences between
the share classes relate to selling commissions and ongoing fees and expenses, which
affect NAV per share of the different share classes and distributions on the different
share classes.

   Class A shares are available to the general public. Class B shares are available

for purchase only (1) through fee-based programs, also known as wrap accounts, of
investment dealers, (2) through participating broker-dealers that have alternative fee
arrangements with their clients, (3) through certain registered investment advisers, (4)
through bank trust departments or any other organization or person authorized to act in
a fiduciary capacity for its clients or customers, (5) by endowments, foundations,
pension funds and other institutional investors, or (6) by Trust's executive officers and
directors and their immediate family members, as well as officers and employees of the
Trust's advisor/sponsor or other affiliates and their immediate family members, and, if
PLR-141373-12 4

approved by Trust’s board of directors, joint venture partners, consultants, and other
service providers.

   During the escrow period, the per share purchase price for shares of each class

of common stock will be $c, plus, for Class A shares only, applicable selling
commissions. Trust will take purchase orders and hold investors’ funds in an interest-
bearing escrow account until it receives purchase orders (excluding purchase orders
received from State C investors) for at least $d, including shares purchased by its
directors, officers and other affiliated persons and entities, in any combination of Class
A and Class B shares of common stock and Trust’s board of directors has authorized
the release of funds in the escrow account, at which time Trust will commence
operations. After the close of the escrow period, each class of shares will be sold at the
NAV per share for such class, plus, for Class A shares only, applicable selling
commissions. Each class of shares may have a different NAV per share because
certain fees and expenses differ with respect to each class.

    State A law permits a corporation to provide by its charter for one or more

classes or series of stock. State A law also requires a corporation that chooses to
divide its stock into classes to include in its articles of incorporation a description of
each class including any preferences, conversions and other rights, voting powers,
restrictions, limitations as to dividends, qualifications, and terms and conditions of
redemption.

   In its Charter, Trust is authorized to issue Class A Common Shares and Class B

Common Shares, as well as preferred stock. The Charter, sometimes by cross-
reference to the Prospectus, provides a description of the various terms and rights of
the Class A shares and Class B shares in accordance with State A law. The separately
designated Class A shares and Class B shares have class-specific voting rights,
separate distribution rights that are a function of allocations of class-specific fees and
expenses, and separate NAVs per share, which, again are a function of allocations of
class-specific fees and expenses, and which result in different redemption and
liquidation amounts. These differences are provided for in the Charter and are
disclosed in the Prospectus.

    In general, the Charter states that each common share, without regard to class,

is entitled to one vote on all matters on which common stockholders are entitled to vote.
Any amendment to the Charter, however, that would materially and adversely change
the preferences, rights, voting powers, or terms of a particular class of common shares
must be approved by the holders of such class.

   Allocations of income and expense to each class of common stock are reflected

in Net Asset Value per Class A Common Share, Net Asset Value per Class B Common
Share and affect the amount of operating distributions, liquidating distributions, and
redemption payments with respect to common stock of a particular class. Net Asset
Value per Class A Common Share and Net Asset Value per Class B Common Share
PLR-141373-12 5

are defined in the Charter by reference to Trust’s Prospectus, as amended from time to
time. The Prospectus explains the process of determining the net asset value of Trust
and allocating changes in net asset value, as well as special allocations of distribution
fees, dealer manager fees, advisory fees, and other class-specific expenses between
Class A shares and Class B shares.

   Pursuant to the Charter, distributions are to be made at the same time on Class

A and Class B shares, and the per share amount of distributions is to be made in
accordance with the Prospectus, as amended from time to time. The Prospectus
explains that per share distributions on Class A shares and Class B shares are
expected to differ because of the allocations of class-specific expenses. For example,
allocations of distribution fees to Class A shares will reduce distributions with respect to
Class A shares but will not affect distributions with respect to Class B shares. The
Prospectus indicates that Trust intends to use the “record share method” for
determining per share distributions.

  Pursuant to the Charter, liquidating distributions are to be made in accordance

with Net Asset Value per Class A Common Share and Net Asset Value per Class B
Common Share.

  Redemptions are also to be made at net asset value per share of the class of

shares being redeemed.

   Class A Common Stock

   Class A shares will be identical to Class B shares in all respects except as

follows:

   • Class A shares will be subject to sales commissions (e percent to the extent not

otherwise waived or reduced and paid directly by the stockholder in addition to the NAV
for such shares). Class A shares are the only shares subject to a sales commission.

  • Class A shares will be allocated distribution fees (daily accrual of f of

g percent of the NAV of the Class A shares for such day). Class A shares are the only
shares that are allocated a distribution fee.

    • The fixed component of the advisory fee is allocated to all classes (daily accrual

of f of h percent of the NAV of the share class for such day). The performance
component is determined with respect to each class applying the same formula, that is,
if the total return for a particular class for a particular year exceeds i percent, Advisor
will be paid j percent of such excess return, provided that in no event will the
performance component exceed b percent of the aggregate total return allocable to
such class for such year. Because of different NAVs per share and different expense
allocations, the performance component of the advisory fee could be payable with
respect to one class but not the other.
PLR-141373-12 6

   • The distributions payable to holders of Class A shares and Class B shares will

be calculated, declared, and distributed at the same time and will differ only by reason
of the special allocation of the distribution fees to the Class A shares, disproportionate
allocations of any specifically identified class-specific expenses, and the possibility that
the foregoing class-specific allocations may produce different performance fees (even
though calculated on the same formula), and differences attributable to different NAVs
of each class.

  • Liquidating distributions with respect to Class A shares are equal to the Net

Asset Value per Class A Common Share, as defined in Trust's Charter.

  • Subject to certain limitations, the share redemption plan is intended to allow

holders of Class A shares to request that Trust redeem their shares. Such shares
would be repurchased at the Net Asset Value per Class A Common Share (subject to a
k percent short-term discount for shares purchased within one year of their purchase).

  • Any amendment to the Charter, however, that would materially and adversely

change the preferences, rights voting powers or terms of the holders of Class A shares
must be approved by the Class A stockholders voting as a class.

   Class B Common Stock

   Class B shares will be identical to Class A shares in all respects except as

follows:

  • No selling commissions will be charged with respect to Class B shares.

Because investors in Class B shares generally pay asset-based fees to their financial
advisors in lieu of commissions, it would not be appropriate to charge commissions with
respect to Class B shares.

   • No distribution fees will be paid with respect to, or allocated to, Class B shares.

Because investors in Class B shares generally pay asset-based fees to their financial
advisors in lieu of commissions, it would not be appropriate to allocate distribution fees
that represent deferred commissions paid to holders of Class B shares.

    • The fixed component of the advisory fee is allocated to all classes (daily accrual

of f of h percent of the NAV of the share class for such day). The performance
component is determined with respect to each class applying the same formula, that is,
if the total return for a particular class for a particular year exceeds i percent, Advisor
will be paid j percent of such excess return, provided that in no event will the
performance component exceed b percent of the aggregate total return allocable to
such class for such year. Because of different NAVs per share and different expense
allocations, the performance component of the advisory fee could be payable with
respect to one class but not the other.
PLR-141373-12 7

   • The distributions payable to holders of Class A shares and Class B shares will

be calculated, declared and distributed at the same time and will differ only by reason of
the special allocation of the distribution fees to the Class A shares, disproportionate
allocations of any specifically identified class-specific expenses, and the possibility that
the foregoing class-specific allocations may produce different performance fees (even
though calculated on the same formula), and differences attributable to different NAVs
of each class.

  • Liquidating distributions with respect to Class B shares are equal to the Net

Asset Value per Class B Common Share, as defined in Trust's Charter.

  • Subject to certain limitations, the share redemption plan is intended to allow

holders of Class B shares to request that Trust redeem their shares. Such shares
would be redeemed at the Net Asset Value per Class B Common Share (subject to a k
percent short-term discount for shares redeemed within one year of their purchase).

   • Any amendment to the Charter, however, that would materially and adversely

change the preferences, rights, voting powers, or terms of the holders of Class B shares
must be approved by the Class B stockholders voting as a class. Each share class may
be allocated a different share of fees and expenses (such as transfer agent fees and
any other class-specific fees and expenses disclosed in a supplement or amendment to
the Prospectus and incorporated into the Charter by reference) that are actually
incurred in different amounts for each class of shares, but there will be no class-specific
fees and expenses related to the management of Trust's assets (for example, advisory
fees or custodial fees).

                                 LAW AND ANALYSIS

   Section 857(a)(1) of the Code requires, in part, that a REIT's deduction for

dividends paid for a tax year (as defined in section 561, but determined without regard
to capital gains dividends) equal or exceed 90% of its REIT taxable income for the tax
year (determined without regard to the deduction for dividends paid and by excluding
any net capital gain).

   Section 561(a) defines the deduction for dividends paid, for purposes of section

857, to include dividends paid during the taxable year.

   Section 561(b) applies the rules of section 562 for determining which dividends

are eligible for the deduction for dividends paid under section 561(a).

    Section 562(c) provides that the amount of any distribution will not be considered

as a dividend for purposes of computing the dividends paid deduction under section 561
unless the distribution is pro rata. The distribution must not prefer any shares of stock
of a class over other shares of stock of that same class. The distribution must not
PLR-141373-12 8

prefer one class of stock over another class except to the extent that one class is
entitled (without reference to waivers of their rights by stockholders) to that preference.
Section 1.562-2 of the Income Tax Regulations provides that a corporation will not be
entitled to a deduction for dividends paid with respect to any distribution upon a class of
stock if there is distributed to any shareholder of such class (in proportion to the number
of shares held by him) more or less than his pro rata part of the distribution as
compared with the distribution made to any other shareholder of the same class. Nor
will a corporation be entitled to a deduction for dividends paid in the case of any
distribution upon a class of stock if there is distributed upon such class of stock more or
less than the amount to which it is entitled as compared with any other class of stock. A
preference exists if any rights to preference inherent in any class of stock are violated.
The disallowance, where any preference in fact exists, extends to the entire amount of
the distribution and not merely to a part of such distribution.

                                 CONCLUSION

    Accordingly, based on the above facts and circumstances, we conclude that the

differences in distributions on the two classes of shares of common stock attributable to
different fee and class-specific expense allocations, including different performance fees
determined through application of the same performance fee formula, will not result in
such distributions being treated as preferential dividends within the meaning of section
562(c), and, therefore, Trust will be entitled to deduct all dividends that it pays to its
stockholders pursuant to sections 561(a) and 857, provided that Trust otherwise meets
the conditions of those sections. Furthermore, Trust’s adoption of the two classes of
common stock with different fee and class-specific expense allocations described above
will not affect the qualification of Trust as a REIT under section 856.

   Except as specifically ruled upon above, no opinion is expressed concerning any

federal income tax consequences relating to the facts herein under any other provision
of the Code. Specifically, we do not rule whether Trust otherwise qualifies as a REIT
under part II of subchapter M of Chapter 1 of the Code. Furthermore, no opinion is
expressed concerning the accuracy of the NAV of Trust’s stock for purposes of
subchapter M.

  This ruling is directed only to the taxpayer requesting it. Taxpayer should attach

a copy of this ruling to each tax return to which it applies. Section 6110(k)(3) of the
Code provides that this ruling may not be used or cited as precedent.
PLR-141373-12 9

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                   Sincerely,


                                   Diana Imholtz
                                   Diana Imholtz
                                   Branch Chief, Branch 1
                                   Office of Associate Chief Counsel
                                   (Financial Institutions & Products)

Enclosures (2):
Copy of this letter
Copy for section 6110 purposes