December 3, 2015

Darden Restaurants and MGM Resorts International Take Different Paths in Unlocking Real Estate Value

Confusion surrounding the recent IRS notice and revenue procedure regarding “PropCo/OpCo” spin-offs caused many companies to reconsider or abandon their REIT spin-off plans. Nevertheless, two companies have publicly announced their plans to pursue them despite the expected increased scrutiny of these transactions. Darden Restaurants, Inc. recently closed on a “traditional” REIT spin-off, while MGM Resorts International announced its intention to contribute certain casino property assets to a new REIT that MGM will control. Both transactions suggest the PropCo/OpCo structure is not “dead.”

In recent years, a number of public companies have sought to unlock the value embedded in their corporate real estate assets by separating the real estate and other assets into two separate entities – a so-called PropCo/OpCo structure – and spinning off one or the other to stockholders in a tax-free transaction. The real estate entity would then lease back most of its assets to the non-real estate company and elect to be treated as a REIT for U.S. federal income tax purposes. A variety of companies across business sectors announced that their respective boards were considering reorganizing into a PropCo/OpCo structure, including, McDonald’s Corp. (NYSE: MCD), Macy’s Inc. (NYSE: M), Darden Restaurants, Inc. (NYSE: DRI) and MGM Resorts International (NYSE: MGM).

As reported in our REIT Alert of September 23, 2015, the Internal Revenue Service recently announced new limitations on the ability of companies to obtain private letter rulings with respect to proposed tax-free spin-off transactions under Section 355 of the Internal Revenue Code.1 Among other things, the IRS declared a moratorium on its willingness to entertain private letter ruling requests if either the distributing or the distributed corporation intends to make a REIT election following the spin-off.2 The IRS’ announcement has caused many companies that had been considering a REIT spin-off to reconsider or even entirely abandon those plans.

Nevertheless, at least two companies have since publicly announced their intention to effect an PropCo/OpCo structure anyway. Darden Restaurants, Inc. (“Darden”) proceeded to commit to and consummate a “traditional” REIT spin-off, while MGM Resorts International (“MGM”) announced its intention to contribute certain casino property assets to a new REIT that MGM will control, thereby implementing an PropCo/OpCo structure without use of a tax-free spin-off. In this Alert we compare and contrast these two transactions based upon what is publicly known at this date.

Darden Spin-Off

Darden announced its plan to transfer about 430 restaurant properties and cash to a new real estate investment trust in June 2015. All of the shares in the REIT, called Four Corners Property Trust, Inc. (“Four Corners”), would be distributed to Darden’s shareholders and Four Corners would have an independent board and management. Four Corners would lease almost all of the contributed properties to Darden under a series of long-term triple-net leases and also take on additional debt financing, allowing Darden to retire a significant portion of its outstanding debt. Through its taxable REIT subsidiary, Four Corners also would operate a line of Darden’s steakhouse restaurants pursuant to franchise agreements with Darden.

A registration statement relating to the public spinoff of Four Corners shares was submitted to the Securities and Exchange Commission in August 2015. Likewise, prior to the IRS’ September 2015 announcement of its moratorium, Darden requested a private letter ruling from the IRS as to the qualification of the Four Corners spin-off as tax-free to Darden and its shareholders. The principal transaction agreement was not signed until October 21, 2015, the date the SEC declared Four Corners’ registration statement effective, at which time the IRS private letter ruling remained pending.3 Tellingly, the transaction agreement did not condition Darden’s obligation to carry out the Four Corners spin-off on receipt of an IRS ruling regarding the tax-free nature of the transaction. Instead, Darden agreed to close, assuming satisfaction or waiver of the other applicable conditions, on the strength of an opinion of outside tax counsel to the effect that the transaction would qualify as tax-free under Sections 355 and 368(a)(1)(D) of the Code. (While not a condition to closing of the spin-off, Darden did, in fact, receive a private letter ruling from the IRS as to “certain issues relevant to the qualification of the spin-off as tax-free)

Darden likely will be one of the last taxpayers for a while to receive comfort from the IRS on PropCo/OpCo REIT spin-offs. Taxpayers will instead now have to rely exclusively on an opinion of outside tax counsel to avoid the draconian impact of being wrong on whether the transaction qualifies as a tax-free spin-off.4 The IRS has commented in public statements that its moratorium on the issuance of private letter rulings does not represent a change in tax law. Accordingly, under the right set of facts and circumstances, as apparently was the case in Darden, outside tax counsel should be able to render an opinion that the spin-off (and related REIT election) will withstand IRS scrutiny.

MGM’s "Captive REIT” Transaction

On October 29, 2015, MGM announced that it plans to create a real estate investment trust subsidiary, MGM Growth Properties LLC (“Growth Properties”), into which it will transfer 10 casino properties subject to $4 billion of debt. The properties contributed to the REIT would not include the Bellagio or MGM Grand Las Vegas, which are larger producers of MGM’s EBITDA than any of the properties that MGM plans to contribute to Growth Properties. Growth Properties will lease the contributed properties back to MGM under a long-term triple-net master lease. Significantly, instead of spinning off Growth Properties to MGM’s shareholders, MGM intends to take Growth Properties public by way of an IPO of shares representing approximately 30-40% of the  overall value of  Growth Properties, with MGM retaining ownership of the remaining 60-70%. As a “captive” REIT, MGM would be sacrificing some (but not all) of the tax benefits of the REIT structure, since MGM will still be required to pay corporate level tax on the dividends from its ownership of Growth Properties.

To date, many of the specifics of the proposed MGM transaction have not been made public. However, we do know that the proposed transaction, at least initially, does not involve a tax-free spin-off and thus does not come with the tax risk created by not being able to obtain an IRS private letter ruling. Conversely, as indicated above, the MGM transaction does not achieve the same beneficial tax results of the Darden transaction since only the 30-40% minority shareholders obtain the benefit of the REIT structure. It is possible MGM intends to reduce its interest in Growth Properties over time by an additional primary or secondary offering or even a future tax-free spin-off but that is unknown. MGM likely has net operating losses and other tax attributes that could offset its share of the dividend income of Growth Properties in the short term. The public record indicates that MGM has structured the Growth Properties transaction to navigate around the “related party tenant” REIT restriction but there are other REIT and tax issues that will need to be addressed.

A leading commentator has suggested that MGM mitigate potential conflict of interest concerns by, among other things, giving Growth Properties an evergreen right of first refusal option to acquire Bellagio, MGM Grand, and perhaps other properties on advantageous terms, creating a strong REIT governance structure without (or with minimal) interlocking directors and providing for a lease structure that contains fair market value rent. While it remains to be seen what MGM’s short term and long term goals and objectives are, the market will be watching closely as MGM provides more details about its structure. 


While Darden and MGM are taking different approaches, both transactions indicate that the PropCo/OpCo structure is not “dead” and the goal of unlocking real estate value is still very much alive.



[1] See Notice 2015-59 and Rev Proc 2015-432, dated September 14, 2015.

[2] The IRS also extended its no-ruling policy to include, among other transactions, spin-offs in which either corporation relies on assets with a value of less than 5% of the corporation’s total assets to satisfy the 5-year “active trade or business” requirement of Section 355. Because PropCo’s business of leasing real estate back to OpCo generally will not satisfy this requirement, a PropCo may need to retain some amount of active business assets (often in a taxable REIT subsidiary, or TRS).

[3] The IRS specifically “grandfathered” in private letter ruling requests received prior to the date of its moratorium announcement.

[4] Both a corporate level and shareholder level tax.