Companies in technology and related fields are testing a way to avoid paying taxes: persuading the government that their real business is real estate.
American Tower Corp., AMT +0.66% which operates cellphone towers, will save more than $400 million a year by 2017, analysts estimate, thanks to its new tax status as a real-estate investment company. Equinix Inc, EQIX -2.56% whose warehouses are full of computer servers, is expected to avoid taxes of around $150 million a year.Iron Mountain Inc., IRM -11.60% which helps clients shred documents and store data, may save nearly as much.
The key: getting approval from the Internal Revenue Service to convert from a corporation into a real-estate investment trust, a type of company that generally doesn't pay taxes.
As both traditional landlords and an increasingly diverse array of other businesses have adopted the structure, the total market value of REITs jumped to $451 billion in 2011 from $9 billion in 1990, according to the National Association of Real Estate Investment Trusts.
Investors typically cheer when companies turn themselves into REITs. But some real-estate executives and analysts worry that the new wave of applicants—including a pair of companies that run private prisons—could spark a political backlash at a time when deficits and taxes are high on Washington's agenda.
"The real-estate companies correctly are nervous about this phenomenon," says Kenneth T. Rosen, a real-estate economics consultant and former manager of a hedge fund that invested in REITs. "The more it looks like a tax loophole, the more likely it is to affect them negatively."
That concern came to the fore last month after Jim Taiclet, American Tower's chief executive,touted the tax benefits of his company's conversion to a REIT in a television interview on business channel CNBC.
"Should we think of you as a real-estate company?" a reporter asked. "You should feel that we're a growth company that's taking advantage of the real-estate trust structure," Mr. Taiclet replied.
The video clip went viral in some corners of the REIT world.
American Tower says its primary business has always been real-estate-based. Mr. Taiclet's remarks on CNBC "merely pointed out that the company could continue its growth trajectory and operate as a REIT," a spokesman says.
Equinix, which unveiled plans a month ago to convert to a REIT, weighed the risk of changes in the tax code, but it wasn't deterred, says CEO Steve Smith. "Our advisers have told us that even if they wanted to change the policy around REIT conversions, it would take years because of the bureaucracy," he says.
Iron Mountain declined to comment.
REITs, which reported $25 billion in profits last year, were created by Congress in 1960. The idea was to let ordinary Americans buy shares in skyscrapers or shopping malls just as they could buy stock in a company or mutual fund.
The basic rules are simple. REITs have to have most of their assets and income tied to real estate, and they must pay out at least 90% of their taxable income as dividends.
The downside of that requirement is that money that could have funded new investments or acquisitions has to be distributed to investors. Still, companies are drawn to the fact REITs generally don't pay corporate tax.
Proponents of expanding the real-estate club argue that it makes sense for the definition of real estate to evolve as technologies change. The IRS for the most part has gone along, ruling in recent years that cellphone towers, billboards, data centers, and other facilities are "inherently permanent structures" that qualify for REIT treatment.
Critics, however, say the expansion risks being at odds with the original intent of Congress.
"The further you allow corporations that engage in a broader range of activities into the REIT cubbyhole, the further the erosion to the tax base," says Steven Rosenthal, a tax lawyer and visiting fellow at the Tax Policy Center who helped draft REIT legislation in the 1990s. "So long as we have a corporate-level tax, we should restrict these pass-through vehicles to limit their activity to holding real-estate investments on behalf of small investors."
A growing number of companies are testing the definition of what qualifies as real estate.
Data-center operator Equinix rents space to companies that need to house roomfuls of computer servers. It also provides services like power and telecom hookups. Existing data-center REITs typically consider that rental income tax free, but Equinix is testing the limits byalso trying to shelter the sums it makes charging clients to connect with the computer systems it houses.
Equinix generated about $68 million, or about 15% of its total revenue, from that "interconnection" business in the second quarter. CoreSite Realty Corp.,COR -0.19% an existing data-center REIT, doesn't account for interconnection fees as tax-exempt real-estate income.
Equinix says the decision is up to the IRS.
Lamar Advertising Co. LAMR +0.38% says its traditional billboards, digital billboards and roadside signs touting food options at the next highway exit could count as rental property. Lamar, whose shares jumped as much as 14% on Aug. 8 after it said it might seek REIT status, didn't reply to requests for comment.
Iron Mountain is well known for its trucks that circulate through city streets collecting documents to be shredded or stored. The company says most of its income comes from the document-storage business, which has similarities to consumer self-storage businesses already established as REITs. But Iron Mountain has warned investors that IRS approval of its REIT conversion isn't assured. It estimates it will spend as much as $425 million on the conversion.
The debate over what businesses can get REIT treatment is likely to heat up. Mark D. Kirshenbaum, a tax lawyer at Goodwin Procter in Boston, says bankers and potential clients have inquired whether it would be possible to include wind, solar, and hydroelectric energy assets in REITs. Mr. Kirshenbaum says it isn't clear that would work.
Politicians have said little about REITs in this election cycle, but perceived abuses have landed in the political cross hairs before. When Republican presidential candidate Mitt Romney was governor of Massachusetts, the state cracked down on banks that had set up REIT subsidiaries to cut their tax bills. Mr. Romney has said he would look to eliminate some tax breaks if he became president, but he hasn't been specific.
UBS AG real-estate analyst Ross Nussbaum warned clients in June that Congress might re-evaluate REIT rules as a wave of "alternative" companies try to reap the structure's tax advantages.
"You have this growing crop of companies who are masquerading as real-estate companies," he says.
