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Tax changes could boost overseas investments in US pipelines, REIT assets

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Tax changes could boost overseas investments in US pipelines, REIT assets

Recentchanges in tax laws for foreign investors in U.S. real estate and real estateinvestment trusts may encourage overseas funds to explore investments in oiland gas pipelines or other qualifying assets organized under a REIT.

Foreignpension funds and sovereign wealth funds are gauging their eligibility for theexemption under the tax rules signed into law in December 2015 to determinewhether investing in certain midstream and real estate assets under a REITcould yield favorable results, legal sources said.

Theserules, modified under the Protecting Americans from Tax Hikes Act, reduce somebarriers to foreign investment in real estate opportunities, the legal expertssaid. Specifically, the act provides a new exemption from the ForeignInvestment in Real Property Tax Act, or FIRPTA, for qualified foreign pensionfunds that gives the foreign investor the same treatment on the sale of realproperty interests as domestic funds. It also exempts capital gainsdistributions from a REIT from taxation under FIRPTA.

Additionally, gains from stock in a publicly traded REITwill be exempt as long as the shareholder owns less than 10% of that class ofstock. The previous exemption had a 5% threshold.

REITinvestments are attractive as they block effectively connected income, notedPeter Genz, a tax attorney at King & Spalding LLP. And although REITs havenot often housed pipeline assets, energy infrastructure REITs are not withoutprecedent.

JamesHoward, chair of the tax group in the Houston office of Gardere Wynne SewellLLP, expects U.S. REITs to explore acquiring pipelines. Howard, who has assistedclients with various FIRPTA provisions, noted that increased investments fromoverseas funds would provide motivation to jump into the space, especially inthe low-price commodity climate where equity and debt markets are expensive forenergy companies to access.

JesseCriz, a Chicago-based partner and co-chair of the national REIT tax practice atDLA Piper LLP, is also optimistic about the potential for the FIRPTAmodification to create an immediate influx of capital from overseas investors.

"Ifa business model makes sense for an existing U.S. REIT to invest in pipelines,then a qualified foreign pension fund looking to increase its exposure will beinterested," he said.

The changes may benefit CorEnergyInfrastructure Trust Inc., the first publicly listed REIT focusedon energy infrastructure.

CorEnergyis addressing calls from various prospective non-U.S. investors who are lookingto glean a better understanding of the assets under its energyinfrastructure-focused REIT structure. So far, the investor response has beenrather positive, the company told S&P Global Market Intelligence.

"Webelieve the REIT structure is the most elegant way to access direct ownershipof these assets. This structure, and our dividend characterization, benefitinvestors who would otherwise have a difficult time accessing these assets, byproviding a 1099 tax form and not a burdensome K-1 form," CorEnergy's CEOand President David Schulte told analysts and investors at its fourth-quarter2015 earnings call in March. MLPs do not pay taxes on their income, but passthrough profits and losses to its partners, which is noted on a Schedule K-1.

A spokewoman for CorEnergy noted that energy companies areoften reluctant to relinquish control of their assets, but their structureallows companies to monetize their assets, while at the same time operatingthem.

GregMatlock, an MLP specialist and Americas energy tax leader at Ernst & Youngin Houston seconded Gardere's Howard on the possibility of pipelines beinghoused in REITs. He said the FIRPTA exemption is one of many considerations inanalyzing whether a non-U.S. person should invest in pipeline assets.

Meanwhile,John Cohn, who represents several international private equity firms as a taxpractice leader in the Dallas office of Thompson & Knight LLP, is skepticalabout the benefits of the FIRPTA exemption. "It's a welcome addition … butit's a much narrower application than the headline advertises," he said.

TheIRS is expected to come out with more guidance about the modifications from thePATH Act this year.