Iron Mountain Incorporated (IRM), Rayonier Inc. (RYN): IRS Rethinking REIT Conversions Is Good News

Penn National Gaming, Inc (NASDAQ:PENN) is even more concerning. The company plans to split itself into a gaming company and a REIT. The company owns gaming and horse racing facilities, and makes its money from gambling. The value isn’t in the facilities, it’s in the over 36,000 slot machines and 800 game tables.

How much rent should the REIT collect from the gaming company? At what level does it go from a legitimate business separation to a tax avoidance scheme? If the ties between the two entities are too close, there are large opportunities for abuse.

Iron Mountain Incorporated (NYSE:IRM), meanwhile, is trying to convince the IRS that its document storage facilities should be considered property. While that’s on sounder footing than a gaming REIT conversion, Iron Mountain Incorporated (NYSE:IRM) also offers services that are hard to consider property related. For example, “data protection & recovery services and information destruction services,” among others. Services represented 42% of the top line in 2012, that’s more than a side business.

Starting early

Luckily, the IRS is stepping in early to rethink the ease with which companies can turn into REITs. It recently informed data center owner Equinix Inc (NASDAQ:EQIX) that “the IRS has convened an internal working group to study what constitutes ‘real estate’ for purposes of the REIT provisions of the Internal Revenue Code of 1986…” Until that working group has come to a conclusion, REIT conversions are likely to be on hold.

Since there are a number of data center REITs in existence already, some of which started public life as REITs, Equinix Inc (NASDAQ:EQIX) is likely to prevail in its desire to change into a REIT. However, Penn National Gaming, Inc (NASDAQ:PENN) and Iron Mountain Incorporated (NYSE:IRM) will probably face more scrutiny. And rightly so.

Good move

This is a good, early move by the IRS. It will help prevent the damage to investors that similar exploitation of the Canadian Royalty Trust structure caused. Indeed, after the Canadian government thought better of allowing operating companies to change their stripes just to avoid taxes, the entire CanRoy sector sold off heavily and there were massive dividend cuts.

REITs are meant to help small investors gain access to institutional level income producing properties. Investors will be well served by the IRS’ scrutiny and by the avoidance of companies that want to be REITs just to avoid paying Uncle Sam his due.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Corrections of America. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article IRS Rethinking REIT Conversions Is Good News originally appeared on Fool.com is written by Reuben Brewer.

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