Utility Conversions into REITs

Publication February 8, 2016

Conversions of US utilities into REITS may be less common after Congress acted in December.

However, at least two conversions remain in the works in Texas.

CenterPoint Energy, a large electric and gas utility headquartered in Houston, said in early February that it is exploring whether to put its transmission and distribution assets under a real estate investment trust. The move could help it save on taxes. A REIT is a corporation or trust that is not taxed on its earnings to the extent the earnings are distributed each year to the owners. Wells Fargo Securities said in a report that the move would provide a “potential value uplift” to the utility.

A group led by the Hunt family that is competing to buy Energy Future Holdings, another utility headquartered in Dallas, has applied to the Public Utility Commission of Texas to convert the company into a REIT that would hold the transmission and distribution assets of a subsidiary, Oncor, and then lease them back to what is currently Oncor. (For more details about how the deal would be structured, see the September 2015 NewsWire article REITs.) 

The Public Utility Commission is expected to rule on the transaction in March. The PUC staff raised questions in a filing in late January about whether the move would leave the operating company that leases the T&D assets starved for cash to pay unexpected costs, like restoring service after major storms. It also suggested the operating company may end up collecting for federal income taxes from ratepayers that would not be paid, at least at the company level.

Congress voted in December to limit the ability of corporations to spin off assets or businesses tax free as part of a REIT conversion on or after December 7, 2015, unless the transaction is described in a IRS ruling request that was pending as of that date. The restriction is part of the tax extenders bill that extended expiring renewable energy tax credits in December. 

The IRS had already put a hold on rulings about tax-free spinoffs of assets in situations where the company is not also spinning off other parts of the company, like customer relationships and employees, that are needed for an active business. The IRS put the subject on its latest business plan, which is a list of issues it hopes to tackle by June 2016.

In the typical utility REIT, passive assets like transmission and distribution lines and towers are put in a REIT and then leased to the operating company. The operating company uses them to serve customers and pays part of its revenue to the REIT as rent. The part paid to the REIT escapes a corporate-level tax. 

Cell tower operator American Tower Corp. converted into a REIT in 2012 and reported $1.2 billion in tax savings through mid-2014. 

Arkansas telecom company Windstream Holdings Inc. spun off its fiber optics and copper lines, real estate and other fixed assets in April 2015 into a separate company that qualifies as a REIT. Windstream said in a securities filing in 2014 that the move would save it $100 million a year in taxes by shifting about 11% of its annual revenue to the REIT through rent for use of the fixed assets.

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