This post is part of the On the Margin blog.
The federal government is apparently getting squeamish about tax-free real estate spinoffs, and that could have big implications for restaurant companies considering such moves — including Darden Restaurants.
This week, the IRS released a notice indicating that it and the U.S. Treasury Department were “concerned” that corporations are using spinoffs of assets to avoid paying taxes on otherwise taxable transactions. So the IRS said it would stop ruling on any request while it studies the issue.
This could apply to existing deals, according to the Wall Street Journal, including one from Darden Restaurants, which in June proposed the spinoff of 424 of its properties into a real estate investment trust, or REIT.
The IRS notice could give other companies pause as they consider options for real estate and other assets. The WSJ mentioned McDonald’s Corp., which is under pressure from activist investors to spin off its vast real estate holdings into a separate company.
A McDonald’s REIT has always been unlikely, but the company has seemed more open to the possibility in recent months. For franchisees that have long opposed such a move, the IRS notice could be seen as something of a relief.
A lot of other restaurant companies also own large swaths of real estate. That includes Bob Evans Farms Inc., which itself is selling real estate in a sale-leaseback deal but has said it would consider a REIT spinoff in future years.
Activist investors have long pushed any restaurant company that owns a lot of its real estate to monetize those assets. Investors believe that restaurant companies often don’t get credit for those assets on Wall Street.
Activists push spinoffs because of those tax implications. If a company sells real estate, it would have to pay taxes on that deal. But if it puts those assets into a separate real estate investment trust and spins that company off to existing shareholders, it wouldn’t have to pay taxes.
To qualify for that tax-free status, the spinoffs have to be of a qualifying business asset — collecting rent on property doesn’t qualify, as the Journal noted.
So many companies that do REITs spin off a small qualifying company as part of the transaction. Darden, for instance, is spinning off a 6-unit LongHorn operation in San Antonio as part of its real estate spinoff.
Yet the IRS is concerned that the qualifying assets being spun off with the other assets like real estate are too small, noting that such distributions “may have become less justifiable.”
Darden spokesman Rich Jeffers said in an email that, “The company is confident that its proposed transaction will satisfy all the requirements of applicable law.”
Darden owns Olive Garden, Long Horn Steakhouse and several other chains. It also owns much of its real estate, which became a central topic in a proxy fight last year. The activist, Starboard Value, ultimately unseated all 12 of Darden’s board members.