TRENDS IN PUBLIC REIT M&A: 2012-2017 16 a corporate level “sting tax.” Material sting taxes may force a buyer in a taxable deal to forgo a basis step up, which may in turn reduce what the buyer is willing to pay. • UPREITs. The presence of an umbrella partnership real estate investment trust, or UPREIT, on either side of the transaction can add significant tax structuring complications to a public REIT M&A deal. In a typical UPREIT structure, the REIT holds all of its assets through its interests in an operating partnership, of which the REIT is the general partner. While the acquisition of the target REIT is governed by the corporate tax rules, the acquisition of the operating partnership is governed by very different partnership tax rules, often with the overlay of “tax protection agreements” for the benefit of certain holders of operating partnership units (“OP units”). Tax protection agreements generally require the operating partnership to indemnify a protected partner for tax gain resulting from (i) taxable sales of assets contributed by the protected partner, (ii) a forced taxable exchange of the protected partner’s OP units without a tax-deferred alternative and/or (iii) the operating partnership’s failure to maintain arrangements (such as minimum levels of nonrecourse debt on contributed assets and debt guarantee opportunities) designed to provide the tax protected partner with a sufficient share of operating partnership liabilities to “cover” the protected partner’s “negative tax capital account” during a specific tax protection period. Stock-for-stock mergers of two public UPREITs. The tax treatment of OP unitholders in a merger of two public UPREITs can be relatively straightforward. Holders of OP units in target’s operating partnership can receive OP units in the surviving operating partnership, essentially receiving a currency that functions much like their original OP units, while the assets to be acquired end up “in the right place” with relatively little effort. The change of control provisions in the operating partnership agreement typically permit such transactions without OP unitholder consent. Unitholders in either operating partnership typically can receive OP units of the surviving operating partnership on a tax deferred basis, at least if the unitholders are allocated sufficient debt of the surviving operating partnership to cover any negative capital accounts. For federal income tax purposes, the larger of the operating partnerships generally continues for tax purposes regardless of the state law structure of the operating partnership merger, so the state law structure of the operating partnership merger can accommodate non-income tax considerations such as transfer taxes and lender and JV partner consents. However, even in a merger of two public UPREITs, there are many potential triggers for gain to unitholders, including sales of unwanted assets, changes in financing strategies (e.g., public debt or other unsecured debt versus property specific mortgages), and loss of favorable grandfather status for existing “bottom dollar” debt guarantees, and thus potential indemnities under tax protection agreements. • DownREITs. Stock-for-stock mergers involving only one UPREIT can be more challenging. In addition to presenting many of the same issues as the UPREIT-to- UPREIT combination, when only one of the parties is an UPREIT, and absent further structuring, the merger transaction results in a “downREIT” structure in which some of the combined company’s assets are held in the operating partnership and some are held at the surviving parent REIT. The parties must consider whether to continue with this structure and/or how to get all the assets into the one operating partnership without excessive costs (such as transfer taxes). In some instances, OP unit holders may have to consent to the downREIT structure remaining in place. • Going Private. Go-private transactions with UPREITs do not present any special problems if the OP unitholders can be cashed out along with the public shareholders (assuming no significant tax protection obligations will be triggered or the resulting indemnity payments are acceptable). Complexity increases if tax protection agreements or the terms of the operating partnership agreement require, or the board otherwise determines, that the OP unit holders must be offered some form of tax deferred currency — such as units in a private partnership going forward — as an alternative to cash, Practice Note. We strongly advise potential targets with REIT qualification issues in their past (as well as REITs on the buy side that want to issue stock to target shareholders) to address any REIT qualification issues early on in any business combination process. Care must also be taken that some aspect of the transaction itself does not jeopardize REIT status. For example, any gain recognized in the transaction must be analyzed under the REIT rules. Likewise, in a tax-free deal, care must be taken to ensure that the target’s pre-merger dividends will be sufficient to “clean out” its REIT taxable income.