Summary SIDLEY UPDATE

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1 DECEMBER 18, 2015 SIDLEY UPDATE Congress Passes REIT and FIRPTA Reforms: REIT Spinoffs Restricted, But Generally Beneficial for Existing REITs and Foreign Investors in U.S. Real Estate Markets On December 18, 2015, Congress passed the Protecting Americans from Tax Hikes Act of 2015, which contains important reform measures for real estate investment trusts (REITs) and non-u.s. investors in U.S. real estate. President Obama is expected to sign the Act into law. The Act generally is good news for REITs and non-u.s. investors, including pension plans and offshore hedge funds, because the reform measures will facilitate foreign investments in U.S. real estate, including U.S. infrastructure projects. The Act, however, significantly restricts REIT spinoff transactions, a popular transaction in recent years for companies with significant real estate assets. Summary Exemption of Non-U.S. Pension Plans from FIRPTA. Under the Foreign Investment in Real Property Tax Act of 1980 (Section 897 and Section 1445), 1 commonly known as FIRPTA, non-u.s. investors are subject to U.S. taxation on dispositions of U.S. real property interests, a term that generally includes actual ownership of U.S. real property (including through partnerships) as well as shares of U.S. real property holding corporations (or USRPHCs), including REITs other than mortgage REITs. 2 In addition, subject to certain limited exceptions, distributions from REITs that are attributable to dispositions of U.S. real property by such distributing REITs are generally subject to FIRPTA such that non-u.s. investors would be required to file U.S. tax returns and would be subject to a 35% withholding tax on such distributions (ECI Distributions). Accordingly, FIRPTA has been a significant impediment to investments by non-u.s. investors in U.S. real estate, including infrastructure projects. Under the Act, non-u.s. pension plans (or entities all of the interests in which are held by such plans) are completely exempt from FIRPTA. For this purpose, a non-u.s. pension plan means any trust, corporation, or other organization or arrangement (a) that is created or organized under the law of a country other than the United States, (b) that is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or persons designated by such employees) of one or more employers in consideration for services rendered, (c) that does not have a single participant or beneficiary with a right to more than 5% of its assets or income, (d) that is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates, and (e) with respect to which, under the laws of the country in which it is established or operates, 1 All Section references are to the Internal Revenue Code of 1986 (the Code). 2 Generally speaking, a U.S. corporation is treated as a USRPHC if 50% or more of the fair market value of all its business assets is attributable to U.S. real estate. Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, ; One South Dearborn, Chicago, IL 60603, ; and 1501 K Street, N.W., Washington, D.C ,

2 Page 2 either (i) contributions made to it, which would otherwise be subject to tax under such laws, are deductible or excluded from the gross income or taxed at a reduced rate, or (ii) taxation of any of its investment income is deferred or taxed at a reduced rate. Accordingly, both public and private non-u.s. pension plans may benefit from this new FIRPTA exemption. This change will be effective for all dispositions and distributions occurring after the date of enactment of the act. Restrictions on Tax Free REIT Spinoffs. Under Section 355, a corporation may distribute to its shareholders the shares of a corporate subsidiary in a manner that is tax-free for both the distributing corporation and its shareholders if certain requirements are met. In recent years, mostly under pressure from activist investors, tax-free spinoffs by corporations with significant real estate assets have been combined with an immediate REIT election in respect of either the distributing corporation or the spun out subsidiary. Typically, the subsidiary (the property company) leases its property back to the distributing corporation (the operating company) under a master lease. These structures are commonly known as REIT spinoffs or opco/propco spinoffs. On the ground that REIT spinoffs permanently remove the appreciation in the real estate assets from the reach of the corporate level tax, REIT spinoffs have been described as the latest Wall Street tax shelter or domestic inversion transactions. In addition, the Internal Revenue Service (IRS) recently issued Notice , announcing that it would study REIT spinoffs. To prevent the further proliferation of REIT spinoffs, the Act provides that Section 355 does not apply if either the distributing corporation or the spun off subsidiary is a REIT, and neither the distributing corporation nor the spun off subsidiary can make a REIT election within the 10-year period following the spinoff. REITs that spin off other REITs or taxable REIT subsidiaries (or TRSs) held for more than three years are exempt from the no REIT spinoff rule. This no REIT spinoff rule is effective for spinoffs occurring after December 7, 2015, except that a REIT spinoff for which an IRS private letter ruling request is pending on that date will be grandfathered. Preferential Dividends Repealed for Publicly Reporting REITs; Alternative Remedies for Certain Compliance Failures. The Act repeals the so called preferential dividend rules, a set of arcane rules that have caused REITs to incur significant compliance costs. This repeal is, however, limited to REITs required to file annual and periodic reports with the SEC under the Securities Exchange Act of Accordingly, both listed REITs and public, non-listed REITs will be exempt from the preferential dividend rules. However, private REITs, often used for joint ventures and real estate funds, will continue to be subject to the preferential dividend rules. This amendment will be effective for REIT distributions occurring after December 31, Another helpful provision of the Act is that if a distribution by a private REIT fails to comply with the requirements of the preferential dividend rules, the Treasury may provide a (new) appropriate remedy to cure such failure if (a) it determines that such failure is inadvertent or is due to reasonable cause and not due to willful neglect, or (b) such failure is a type of failure that it has identified as being described in clause (a). Size of TRSs Limited to 20% of REIT s Gross Asset Value. Under prior law, one or more TRSs of a REIT could constitute up to 25% of the gross asset value of a REIT. Under the Act, this size restriction on TRSs is reduced to 20%. This amendment is effective for tax years beginning after December 31, 2017, thereby granting REITs that are close to the 25% limit a transition period to restructure their operations to comply with the lower 20% limit. Publicly Traded Exceptions from FIRPTA Significantly Expanded for REITs. In general, gains from taxable dispositions of stock in USRPHCs (such as most private or public REITs other than mortgage REITs) by non-u.s. investors (including offshore funds) are subject to U.S. tax under FIRPTA even if the non-u.s.

3 Page 3 investors are eligible for the protections of an income tax treaty. An exception applies if a person has held no more than 5% of the stock of a USRPHC the shares of which are regularly traded on a securities exchange. A similar publicly traded exception applies to ECI Distributions by a REIT. The Act broadens the availability of these exceptions for REITs by increasing this 5% threshold to 10% for both publicly traded exceptions. 3 In addition, the Act provides a new exception from FIRPTA for qualified shareholders. Under the qualified shareholder exception, (a) stock of a REIT that is held directly (or indirectly through one or more partnerships) by a qualified shareholder will not be treated as a U.S. real property interest under FIRPTA, and (b) notwithstanding the FIRPTA rules regarding ECI Distributions, to the extent clause (a) applies to the REIT stock, any distribution by a REIT to a qualified shareholder will not be treated as an ECI Distribution. In the case of a qualified shareholder with one or more applicable investors (generally, a 10% owner of the REIT on a lookthrough basis, taking into account all interests held by the applicable investor in the REIT), the favorable rule in clause (a) above will not apply to the percentage of the REIT stock held by a qualified shareholder that is properly attributable to applicable investors. In addition, the same percentage of the amounts realized by the qualified shareholder with respect to any disposition of REIT stock (or with respect any distribution from the REIT attributable to gain from sales or exchanges of U.S. real property interests) will be treated as amounts subject to U.S. tax under FIRPTA. These two rules are referred to as the Applicable Investor Exception. If a REIT distribution to a qualified shareholder is treated as a sale or exchange of REIT stock under Section 301(c)(3), Section 302, or Section 331, then (a) in the case of an applicable investor, the Applicable Investor Exception will apply (that is, the general ECI Distribution rules will apply to such portion of the distribution), and (b) in the case of any other person, such REIT distribution will be treated under Section 857(b)(3)(F) as a dividend from a REIT notwithstanding any other provision of the Code. The term qualified shareholder means a foreign person that (a) (i) is eligible for benefits of an income tax treaty with the United States and the principal class of interests of which is listed and regularly traded on one or more recognized stock exchanges, or (ii) is a foreign partnership that is created or organized under foreign law as a limited partnership in a jurisdiction that has an agreement for the exchange of information with respect to taxes with the United States and has a class of limited partnership units which is regularly traded on the New York Stock Exchange or NASDAQ Stock Market and such class of limited partnership units value is greater than 50% of the value of all the partnership units, (b) is a qualified collective investment vehicle, 4 and (c) maintains records on the identity of each person who, at any time during the foreign person s taxable year, holds directly 5% or more of the class of interest described in clause (a) above. 3 Section 897(c)(3)(sales) and Section 897(h)(1)(ECI Distributions). 4 For this purpose, qualified collective investment vehicle means a foreign person (a) that, under the comprehensive income tax treaty is eligible for a reduced rate of withholding with respect to ordinary dividends paid by a REIT even if such person holds more than 10% of the stock of such REIT, (b) that (i) is a publicly traded partnership to which subsection (a) of Section 7704 does not apply, (ii) is a withholding foreign partnership, (iii) if such foreign partnership were a United States corporation, would be a USRPHC at any time during the 5-year period ending on the date of disposition of, or distribution with respect to, such partnership s interests in a REIT, or (c) that is designated as a qualified collective investment vehicle by the Secretary and is either (i) fiscally transparent within the meaning of Section 894, or (ii) required to include dividends in its gross income, but entitled to a deduction for distributions to persons holding interests (other than interests solely as a creditor) in such foreign person.

4 Page 4 This amendment applies to dispositions and distributions on or after the date of enactment. Domestically Controlled Exception from FIRPTA Clarified. If a non-u.s. investor sells shares of a domestically controlled REIT (that is, a REIT less than 50% of the shares of which at all times have been held, directly or indirectly, by non-u.s. persons), the gain from such sales is exempt from U.S. tax under FIRPTA. The determination of domestically controlled status has been difficult because it was not always clear how to count direct and indirect U.S. shareholders of a REIT for this purpose, particularly in the context of public REITs. Under the Act, for purposes of determining domestically controlled REIT status, (a) in the case of any class of stock of a REIT that is regularly traded on an established securities market in the United States, a person holding less than 5% of such class of stock at all times during the testing period (generally five years) will be treated as a U.S. person, unless the REIT has actual knowledge that such person is not a United States person, and (b) any stock in a REIT held by another REIT or a regulated investment company (RIC) (i) any class of stock of which is regularly traded on an established securities market, or (ii) which is a RIC that issues redeemable securities (within the meaning of Section 2 of the Investment Company Act of 1940), will be treated as held by a non-u.s. person, except that if such other REIT or RIC is itself domestically controlled (determined after application of this rule) such stock will be treated as held by a U.S. person, and (iii) any stock in a REIT held by any other REIT or RIC not described above will only be treated as held by a U.S. person in proportion to the stock of such other REIT or RIC which is (or is treated under the provisions above as) held by a U.S. person. This amendment takes effect on January 1, Sting Tax Period Reduced from 10 Years to 5 Years. If a regular C corporation converts into a REIT or if a REIT acquires assets from a regular C corporation in a tax-free transaction, then the REIT will, under Section 1374, remain subject to corporate level tax in respect of the built-in gain in the C corporation s assets at the time of the conversion or acquisition for a period of 10 years. This is commonly known as the sting tax. Under the Act, the sting tax period is permanently reduced from 10 years to five years. This amendment is effective for tax years beginning after December 31, Prohibited Transactions Safe Harbor for REITs Improved. REITs are subject to a 100% tax on gains from prohibited transactions (that is, gain from the disposition of dealer property). The REIT rules provide, however, a safe harbor against the application of the prohibited transaction tax. That safe harbor applies if (a) the REIT has held the property for not less than 2 years, (b) aggregate expenditures made by the REIT, or any partner of the REIT, during the two-year period preceding the date of sale that are includible in the tax basis of the property do not exceed 30% of the net selling price of the property; (c) either (i) during the tax year the REIT does not make more than seven sales of property (other than sales of foreclosure property or sales to which Section 1033 applies), or (ii) the aggregate adjusted tax bases (as determined for purposes of computing earnings and profits) of property (other than sales of foreclosure property or sales to which Section 1033\applies) sold during the tax year does not exceed 10% of the aggregate tax bases of all of the assets of the REIT as of the beginning of the tax year, or (iii) the fair market value of property (other than sales of foreclosure property or sales to which section 1033 applies) sold during the tax year does not exceed 10% of the fair market value of all of the assets of the REIT as of the beginning of the tax year, and (d) certain other requirements are met. Under the Act, a REIT will now satisfy the requirements of clause (c)(ii) above by substituting 20% for 10% and the three-year average adjusted tax bases percentage does not exceed 10%, or a REIT will satisfy the requirements of clause (c)(iii) by substituting 20% for 10% and the three-year average fair market value percentage does not exceed 10%. The three-year average percentage (for tax bases or fair market value purposes,

5 Page 5 as the case may be) means, with respect to any tax year, the ratio of (a) the aggregate adjusted tax bases or fair market values of property (other than sales of foreclosure property or sales to which Section 1033 applies) sold during the three-tax year period ending with such tax year, divided by (b) the sum of the aggregate adjusted tax bases or fair market values of all of the assets of the REIT as of the beginning of each of the three tax years that are part of the period referred to in clause (a). In addition, the Act clarifies that, in connection with the prohibited transaction safe harbor, certain marketing and development activities may be conducted not only through an independent contractor but also through a TRS. These changes grant REITs more flexibility in respect of sales because it allows the concentration of more sales in one tax year than under the old rules. This amendment is effective for all tax years that begin after the date of the enactment of the Act (i.e., generally the calendar year 2016). Debt Instruments of Publicly Reporting REITs Are Good REIT Assets. Under prior law, REIT shares, but not REIT debt, have been good REIT assets for purposes of the 75% asset test. Under the Act, unsecured debt instruments issued by publicly offered REITs (i.e., listed REITs and public, non-listed REITs) are now also treated as good REIT assets for purposes of the 75% asset test, but only if the value of those debt instruments does not exceed 25% of the gross asset value of the REIT. The interest income and any gain from the disposition of such debt instruments is bad income for purposes of the 75% income test, but is good income for purposes of the 95% income test. This amendment is effective for tax years beginning after December 31, FIRPTA Cleansing Rule Turned Off for REITs. Under prior law, FIRPTA did not apply to the gain recognized in respect of shares of a USRPHC, if (a) all of the United States real property interests held by such U.S. corporation at any time during the relevant testing period were disposed of in transactions in which the full amount of the gain (if any) was recognized, and (b) as of the date of the disposition of such shares, such U.S. corporation did not hold any United States real property interests. This rule is commonly known as the FIRPTA cleansing rule. The logic of the cleansing rule is that the gain on the U.S. real property has already been subject to one level of U.S. tax so there is no need for a second level of U.S. tax by way of taxing the stock sale. That rationale, however, does not apply to REITs. Accordingly, the Act provides that the FIRPTA cleansing rule does not apply to U.S. corporations (or any of their predecessors) that have been REITs during the relevant testing period. This change is applicable for tax years beginning after the date of the enactment of the Act (i.e., generally calendar year 2016). FIRPTA Withholding Tax Increased to 15%. Under FIRPTA, unless an exemption applies, a withholding tax of 10% applies to the sale of U.S. real property interests by non-u.s. persons. The Act increases the tax rate for that withholding tax to 15%. This change is effective for dispositions occurring 60 days after the date of the enactment of the Act. Initial Observations The foregoing summary does not reflect all the changes made by the Act. There are, for example, other changes regarding personal property or hedging transactions. Our initial observations are as follows: Perhaps the most important change made by the Act is the exemption from FIRPTA for non-u.s. pension plans. We expect non-u.s. pension plans will increase their investments in U.S. real estate, including U.S. infrastructure projects, given this change. It should be noted, however, that the benefits are limited to pension plans. Accordingly, foreign government investors that rely on Section 892 but

6 Page 6 that are not pension plans will not benefit from this pension plan exemption from FIRPTA. The reasons for treating Section 892 investors and pension plans (whether private or public) differently in this regard are not clear. We would expect to see fewer REIT spinoffs in the near-term. It is worth noting that the Act did not adopt additional anti opco/propco proposals that have targeted the lease contracts between the operating corporation and the property corporation. 5 Accordingly, it is likely that the market will consider alternative structures to achieve similar results. We would expect that, on balance, the REIT M&A market will benefit from the shortened sting tax period because it will facilitate the rightsizing of portfolios after M&A transactions. The new qualified shareholder exemption from FIRPTA may affect the structuring of REIT M&A transactions. We will continue to monitor these developments closely. If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or Christian Brause Partner cbrause@sidley.com David C. Miller Partner dmiller@sidley.com Ivy H. Jones Partner ijones@sidley.com Tax Practice Our Tax Practice provides legal services in transactions, planning and controversy related to United States federal, state and local and United Kingdom tax laws. Our lawyers work closely with our clients and with lawyers in the firm s other practice groups to develop timely, cost-effective tax strategies and to identify and solve potential tax-related problems. To receive Sidley Updates, please subscribe at BEIJING BOSTON BRUSSELS CENTURY CITY CHICAGO DALLAS GENEVA HONG KONG HOUSTON LONDON LOS ANGELES NEW YORK PALO ALTO SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C. Sidley Austin refers to Sidley Austin LLP and affiliated partnerships as explained at Rules have been proposed regarding limitations on fixed percentage rents if a REIT (the propco) has rental income from only very few corporate tenants (the opco).