EXHIBIT 99.1
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Form 8-K includes forward-looking statements. Any amendment to
this Form 8-K also may include forward-looking statements. We have based these
forward-looking statements on our current expectations about future events.
We identify forward-looking statements in this Form 8-K (and will
identify forward-looking statements in any amendments to this Form 8-K) by using
words or phrases such as "anticipate," "believe," "estimate," "expect,"
"intend," "may be," "objective," "plan," "predict," "project" and "will be" and
similar words or phrases, or the negative thereof.
These forward-looking statements are subject to numerous assumptions,
risks and uncertainties. Factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by us in those statements include, among
others, the risk factors described in our Form 10-K under the caption "Risk
Factors" in our Form 10-K for the year ended December 31, 2003.
MATERIAL FEDERAL INCOME TAX CONSIDERATIONS
Introduction
The following discussion describes the federal income tax
considerations reasonably anticipated to be material to prospective holders in
connection with the purchase, ownership and disposition of common shares of
beneficial interest of ElderTrust. The following discussion is intended to
address only those federal income tax considerations that are generally relevant
to all shareholders, is not exhaustive of all possible tax considerations and is
not tax advice. For example, it does not give a detailed description of any
state, local or foreign tax considerations. In addition, the discussion does not
purport to deal with all aspects of taxation that may be relevant to a
shareholder subject to special treatment under the federal income tax laws,
including, without limitation, insurance companies, financial institutions or
broker-dealers, tax-exempt organizations or foreign corporations and persons who
are not citizens or residents of the United States.
The information in this section is based on the Internal Revenue Code
and regulations in effect on the date hereof, current administrative
interpretations and positions of the Internal Revenue Service and existing court
decisions. No assurance can be given that future legislation, regulations,
administrative interpretations and court decisions will not significantly
change, perhaps retroactively, the law on which the information in this section
is based. Even if there is no change in applicable law, no assurance can be
provided that the statements set forth in this discussion will not be challenged
by the IRS or will be sustained by a court if so challenged.
Because the specific tax attributes of a prospective purchaser could
have a material impact on the tax consequences associated with the purchase,
ownership and disposition of the common shares of ElderTrust, it is essential
that each prospective purchaser consult with his or her own tax advisors with
regard to the application of the federal income tax laws to his or her personal
tax situation, as well as any tax consequences arising under the laws of any
state, local or foreign taxing jurisdiction.
Federal Income Taxation of ElderTrust
General
ElderTrust is a self-managed and self-administered real estate
investment trust, or REIT, that invests principally in senior housing and other
healthcare facilities, primarily skilled nursing facilities, assisted and
independent living facilities (or "senior living centers") and medical office
and other buildings. ElderTrust was formed in the State of Maryland on September
23, 1997 and began operations upon the completion of its initial public offering
on January 30, 1998 (the "Offering"). ElderTrust conducts its business as an
umbrella partnership REIT, through ElderTrust Operating Limited Partnership
(which is referred to in this discussion as the "Operating Partnership"), of
which ElderTrust is the sole general partner.
ElderTrust made an election to be taxed as a REIT under the Internal
Revenue Code, commencing with its taxable year ended December 31, 1998.
ElderTrust believes that it is organized and has operated in a manner that has
permitted it to qualify as a REIT since 1998, and ElderTrust currently intends
to continue to operate as a REIT for future years. No assurance, however, can be
given that it in fact has qualified or will remain qualified as a REIT. See
"--Failure of ElderTrust to Qualify as a REIT" below.
The sections of the Internal Revenue Code and the corresponding
regulations that govern the federal income tax treatment of a REIT and its
shareholders are highly technical and complex. The following discussion is
qualified in its entirety by the applicable Internal Revenue Code provisions,
rules and regulations promulgated thereunder, and administrative and judicial
interpretations thereof.
ElderTrust's qualification and taxation as a REIT depend upon its
ongoing ability to meet the various qualification tests imposed under the
Internal Revenue Code, which are discussed below. No assurance can be given that
the actual results of ElderTrust's operations for any particular taxable year
will satisfy such requirements.
If ElderTrust qualifies for taxation as a REIT, it generally will not
be subject to federal corporate income taxes on its net income that it currently
distributes to its shareholders. This treatment substantially eliminates the
"double taxation" at the corporate and shareholder levels that generally results
from an investment in a regular corporation. However, ElderTrust will be subject
to federal income tax as follows:
1. ElderTrust will be taxed at regular corporate rates on any
undistributed "REIT taxable income," including undistributed net
capital gains; provided, however, that properly designated
undistributed capital gains will effectively avoid taxation at the
shareholder level. A REIT's "REIT taxable income" is the otherwise
taxable income of the REIT subject to certain adjustments, including a
deduction for dividends paid.
2. Under certain circumstances, ElderTrust (or its shareholders) may be
subject to the "alternative minimum tax" due to its items of tax
preference and alternative minimum tax adjustments.
3. If ElderTrust has net income from the sale or other disposition of
"foreclosure property" which is held primarily for sale to customers in
the ordinary course of business or other nonqualifying income from
foreclosure property, it will be subject to tax at the highest
corporate rate on such income.
4. ElderTrust's net income from "prohibited transactions" will be
subject to a 100% tax. In general, "prohibited transactions" are
certain sales or other dispositions of property held primarily for sale
to customers in the ordinary course of business other than foreclosure
property or sales to which Section 1033 of the Internal Revenue Code
applies.
5. If ElderTrust fails to satisfy the 75% gross income test or the 95%
gross income test discussed below, but nonetheless maintains its
qualification as a REIT because certain other requirements are met, it
will be subject to a tax equal to (a) the gross income attributable to
the greater of (i) the amount by which 75% of its gross income exceeds
the amount qualifying under the 75% gross income test described below
under "-- Income Tests Applicable to REITs," and (ii) the amount by
which 90% of its gross income exceeds the amount qualifying under the
95% gross income test described below multiplied by (b) a fraction
intended to reflect its profitability.
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6. If ElderTrust fails to distribute during each calendar year at least
the sum of (a) 85% of its REIT ordinary income for such year, (b) 95%
of its REIT capital gain net income for such year, and (c) any
undistributed taxable income from prior periods, ElderTrust will be
subject to a 4% excise tax on the excess of such required distribution
over the sum of amounts actually distributed and amounts retained but
with respect to which federal income tax was paid.
7. If arrangements between ElderTrust, its tenants and any of its
taxable REIT subsidiaries are not comparable to similar arrangements
among unrelated parties, ElderTrust may be subject to a 100% penalty
tax on certain amounts received by ElderTrust from, or on certain
amounts deducted by, a taxable REIT subsidiary.
8. Where ElderTrust has acquired or acquires any asset from a taxable
"C" corporation, if ElderTrust recognizes gain on the disposition of
such asset during the ten-year period beginning on the date on which
such asset was acquired by ElderTrust, then, to the extent of the
asset's "built-in gain," such gain will be subject to tax at the
highest regular corporate rate applicable. Built-in gain is the excess
of the fair market value of an asset over ElderTrust's adjusted basis
in the asset, determined when ElderTrust acquired the asset.
In addition, notwithstanding ElderTrust's status as a REIT, ElderTrust
may also have to pay certain state income taxes, because not all states treat
REITs the same as they are treated for federal income tax purposes.
Requirements for Qualification
The Internal Revenue Code defines a REIT as a corporation, trust or
association
(1) which is managed by one or more directors or trustees;
(2) the beneficial ownership of which is evidenced by transferable
shares or by transferable certificates of beneficial interest;
(3) which would be taxable as a domestic corporation, but for Sections
856 through 859 of the Internal Revenue Code;
(4) which is neither a financial institution nor an insurance company
subject to certain provisions of the Internal Revenue Code;
(5) the beneficial ownership of which is held by 100 or more persons;
(6) during the last half of each taxable year, not more than 50% in
value of the outstanding stock of which is owned, actually or
constructively, by five or fewer individuals (as defined in the
Internal Revenue Code to include certain entities);
(7) which makes an election to be taxable as a REIT for the current
taxable year, or has made this election for a previous taxable year
which has not been revoked or terminated, and satisfies all relevant
filing and other administrative requirements established by the
Internal Revenue Service that must be met to elect and maintain REIT
status; and
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(8) which meets certain other tests, described below, regarding the
nature of its income and assets.
Conditions (1) to (4) must be met during the entire taxable
year and condition (5) must be met during at least 335 days of a
taxable year of twelve months, or during a proportionate part of a
taxable year of less than twelve months. Conditions (5) and (6) did not
apply to ElderTrust's 1998 taxable year
For purposes of determining stock ownership under condition (6) above,
a supplemental unemployment compensation benefits plan, a private foundation or
a portion of a trust permanently set aside or used exclusively for charitable
purposes generally is considered an individual. However, a trust that is a
qualified trust under Internal Revenue Code Section 401(a) generally is not
considered an individual, and beneficiaries of a qualified trust are treated as
holding shares of a REIT in proportion to their actuarial interests in the trust
for purposes of condition (6) above.
In connection with condition (6), ElderTrust is required to send annual
letters to its shareholders requesting information regarding the actual
ownership of its shares of beneficial interest. If ElderTrust complies with this
requirement, and it does not know, or exercising reasonable diligence would not
have known, whether it failed to meet condition (6), then it will be treated as
having met condition (6). If ElderTrust fails to send such annual letters, it
will be required to pay either a $25,000 penalty or, if the failure is
intentional, a $50,000 penalty. The IRS may require ElderTrust, under those
circumstances, to take further action to ascertain actual ownership of its
shares of beneficial interest, and failure to comply with such an additional
requirement would result in an additional $25,000 (or $50,000) penalty. No
penalty would be assessed in the first instance, however, if the failure to send
the letters were due to reasonable cause and not to willful neglect.
ElderTrust believes that it meets and currently intends to continue to
meet conditions (1) through (4), (7) and (8). In addition, ElderTrust believes
that it has had and currently intends to continue to have outstanding common
shares with sufficient diversity of ownership to allow it to satisfy conditions
(5) and (6). With respect to condition (6), ElderTrust has complied and
currently intends to continue to comply with the requirement that it send annual
letters to its shareholders requesting information regarding the actual
ownership of its shares of beneficial interest. In addition, ElderTrust's
Declaration of Trust contains an ownership limit that is intended to assist
ElderTrust in continuing to satisfy the share ownership requirements described
in (5) and (6) above. The ownership limit, together with compliance with the
annual shareholder letter requirement described above, however, may not ensure
that ElderTrust will, in all cases, be able to satisfy the share ownership
requirements described above. If ElderTrust fails to satisfy such share
ownership requirements, ElderTrust will not qualify as a REIT. See "--Failure of
ElderTrust to Qualify as a REIT" below.
A corporation may not elect to become a REIT unless its taxable year is
the calendar year. ElderTrust's taxable year is the calendar year.
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Absence of "Earnings and Profits" Attributable to "C" Corporation
Taxable Years
A REIT will be taxed as though it did not make a REIT election if it
has at the end of any taxable year any undistributed earnings and profits
("E&P") that are attributable to a "C" corporation taxable year. ElderTrust was
formed in 1997 but was not active until the date of the Offering, January 30,
1998. Because it was inactive, ElderTrust did not satisfy the requirements for
qualification as a REIT for its short taxable year ended December 31, 1997.
ElderTrust therefore made its election to be taxed as a REIT for its taxable
year ended December 31, 1998. ElderTrust believes that it did not have any
earnings and profits from its taxable year ended December 31, 1997 or from the
period prior to the date of the Offering, January 30, 1998.
Qualified REIT Subsidiary
If a REIT owns a corporate subsidiary that is a "qualified REIT
subsidiary," the separate existence of that subsidiary will be disregarded for
federal income tax purposes and all assets, liabilities and items of income,
deduction and credit of the subsidiary will be treated as assets, liabilities
and tax items of the REIT itself. Generally, a qualified REIT subsidiary is a
corporation all of the capital stock of which is owned by one REIT and that is
not a taxable REIT subsidiary. These entities are not subject to federal
corporate income taxation, although they may be subject to state and local
taxation in certain jurisdictions.
Ownership of Partnership Interests by a REIT
A REIT that is a partner in a partnership will be deemed to own its
proportionate share of the assets of the partnership and will be deemed to be
entitled to the income of the partnership attributable to such share. In
addition, the character of the assets and gross income of the partnership
retains the same character in the hands of the REIT for purposes of the gross
income tests and the asset tests applicable to REITs, as described below. Thus,
ElderTrust's proportionate share of the assets and items of income of the
Operating Partnership, including the Operating Partnership's share of such items
of its subsidiaries that are partnerships or LLCs that have not elected to be
treated as corporations for federal income tax purposes, are treated as assets
and items of income of ElderTrust for purposes of applying the requirements
described herein. A summary of the rules governing the federal income taxation
of partnerships and their partners is provided below in "--Tax Aspects of
ElderTrust's Ownership of Interests in the Operating Partnership." As the sole
general partner of the Operating Partnership, ElderTrust has direct control over
the Operating Partnership and indirect control over the subsidiaries in which
the Operating Partnership or a subsidiary has a controlling interest. ElderTrust
believes that it has operated and will continue to operate these entities in a
manner consistent with the requirements for qualification of ElderTrust as a
REIT.
Income Tests Applicable to REITs
In order to maintain qualification as a REIT, ElderTrust must satisfy
the following two gross income requirements:
o At least 75% of ElderTrust's gross income, excluding gross income
from "prohibited transactions," for each taxable year must be
derived directly or indirectly from investments relating to real
property or mortgages on real property, including "rents from
real property," gains on the disposition of real estate,
dividends paid by another REIT and interest on obligations
secured by mortgages on real property or on interests in real
property, or from some types of temporary investments.
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o At least 95% of ElderTrust's gross income, excluding gross income
from "prohibited transactions," for each taxable year must be
derived from any combination of income qualifying under the 75%
test, dividends, interest, some payments under hedging
instruments and gain from the sale or disposition of stock or
securities, including some hedging instruments.
Rents paid pursuant to ElderTrust's leases and interest paid pursuant
to ElderTrust's loans to third parties, together with gain on the disposition of
assets and dividends and interest received from one of ElderTrust's "taxable
REIT subsidiaries," ET Capital Corp., have historically constituted
substantially all of the gross income of ElderTrust. A taxable REIT subsidiary
is an entity taxable for federal and state income tax purposes as a corporation
in which a REIT directly or indirectly holds stock or other equity interests,
that has made a joint election with the REIT to be treated as a taxable REIT
subsidiary and that does not engage in certain prohibited activities, including,
without limitation, operating or managing health care facilities, such as the
senior living centers. For a more detailed discussion of taxable REIT
subsidiaries, see "--Qualification of an Entity as a Taxable REIT Subsidiary"
below. Two of ElderTrust's subsidiaries, ET Capital Corp. and ET Capital Corp.
II, Inc., elected and, ElderTrust believes, have operated and will continue to
operate so as to qualify, to be treated as a taxable REIT subsidiary for federal
income tax purposes.
Several conditions must be satisfied in order for the rents received by
ElderTrust to qualify as "rents from real property." First, the amount of rent
must not be based in whole or in part on the income or profits of any person. An
amount received or accrued generally will not be excluded from the term "rents
from real property" solely by reason of being based on a fixed percentage or
percentages of receipts or sales.
Second, rents received from a tenant will not qualify as "rents from
real property" if ElderTrust, or an actual or constructive owner of 10% or more
of ElderTrust, actually or constructively owns 10% or more of the tenant. This
type of tenant is referred to below as a "related party tenant."
Third, if rent attributable to personal property leased in connection
with a lease of real property is greater than 15% of the total rent received
under the lease, then the portion of rent attributable to such personal property
will not qualify as "rents from real property." Under prior law, this 15% test
was based on relative adjusted tax bases. For taxable years beginning after
December 31, 2000, however, the test is based on relative fair market values.
Fourth, if ElderTrust operates or manages a property or furnishes or
renders certain "impermissible services" to the tenants at the property, and the
income derived from the services exceeds one percent of the total amount
received by ElderTrust with respect to the property, then no amount received by
ElderTrust with respect to the property will qualify as "rents from real
property." Impermissible services are services other than services (1) "usually
or customarily rendered" in connection with the rental of real property and (2)
not otherwise considered "rendered to the occupant." For these purposes, the
income that ElderTrust is considered to receive from the provision of
"impermissible services" will not be less than 150% of the cost of providing the
service. If the amount so received is one percent or less of the total amount
received by ElderTrust with respect to the property, then only the income from
the impermissible services will not qualify as "rents from real property."
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There are two exceptions to this rule. First, impermissible services
can be provided to tenants through an independent contractor from whom
ElderTrust derives no income. To the extent that impermissible services are
provided by an independent contractor, the cost of the services generally must
be borne by the independent contractor. Second, for ElderTrust's taxable years
beginning after December 31, 2000, impermissible services can be provided to
tenants at a property by a taxable REIT subsidiary (subject to the restriction,
noted above, that prohibits a taxable REIT subsidiary from operating or managing
health care facilities).
Each of ElderTrust's senior living centers, which includes the land (if
owned), buildings, improvements and related rights, is leased pursuant to a
long-term lease. These leases generally have a fixed term of five to 12 years
and contain multiple five to 10-year renewal options. Some of these leases
provide for rents based on a specified percentage of facility operating revenues
with no required minimum rent ("percentage rent leases"). Other leases provide
for base rent, increasing each year by the lesser of five percent of the
increase in facility revenues for the immediately preceding year or one-half of
the percentage increase in the Consumer Price Index for the immediately
preceding year ("minimum rent leases"). Both types of leases are triple net
leases that require the lessees to pay all operating expenses, taxes, insurance,
maintenance and other costs, including a portion of capitalized expenditures.
The base rents for the renewal periods are generally fixed rents set at a spread
above the Treasury yield for the corresponding period. The remaining leases
("fixed rent leases") are with tenants in the medical office and other buildings
and provide for specified annual rents, subject to annual increases in some of
the leases. Generally, these leases are for a five-year period.
For the rent paid pursuant to the leases to constitute "rents from real
property," the leases must be respected as true leases for federal income tax
purposes. Accordingly, the leases cannot be treated as service contracts, joint
ventures or some other type of arrangement. The determination of whether the
leases are true leases for federal income tax purposes depends upon an analysis
of all the surrounding facts and circumstances. In making such a determination,
courts have considered a variety of factors, including the following:
o the intent of the parties;
o the form of the agreement;
o the degree of control over the property that is retained by the
property owner (e.g., whether the lessee has substantial control
over the operation of the property or whether the lessee was
required simply to use its best efforts to perform its
obligations under the agreement); and
o the extent to which the property owner retains the risk of loss
with respect to the property (e.g., whether the lessee bears the
risk of increases in operating expenses or the risk of damage to
the property) or the potential for economic gain (e.g.,
appreciation) with respect to the property.
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In addition, Section 7701(e) of the Internal Revenue Code provides that
a contract that purports to be a service contract or a partnership agreement is
treated instead as a lease of property if the contract is properly treated as
such, taking into account all relevant factors, including whether or not: (i)
the service recipient is in physical possession of the property; (ii) the
service recipient controls the property; (iii) the service recipient has a
significant economic or possessory interest in the property (e.g., if the
property's use is likely to be dedicated to the service recipient for a
substantial portion of the useful life of the property, the recipient shares the
risk that the property will decline in value, the recipient shares in any
appreciation in the value of the property, the recipient shares in savings in
the property's operating costs or the recipient bears the risk of damage to or
loss of the property); (iv) the service provider does not bear any risk of
substantially diminished receipts or substantially increased expenditures if
there is nonperformance under the contract; (v) the service provider does not
use the property concurrently to provide significant services to entities
unrelated to the service recipient; and (vi) the total contract price does not
substantially exceed the rental value of the property for the contract period.
Since the determination of whether a service contract should be treated as a
lease is inherently factual, the presence or absence of any single factor may
not be dispositive in every case.
The percentage rent leases and the minimum rent leases have been
structured with the intent to qualify as true leases for federal income tax
purposes. For example, with respect to each lease:
o the Operating Partnership or the applicable subsidiary or other
lessor entity and the lessee intend for their relationship to be
that of a lessor and lessee, and such relationship is documented
by a lease agreement;
o the lessee has the right to exclusive possession and use and
quiet enjoyment of the senior living centers covered by the lease
during the term of the lease;
o the lessee bears the cost of, and will be responsible for,
day-to-day maintenance and repair of the senior living centers
(other than the cost of certain capital expenditures), and
operates and maintains the property subject to the lease;
o the lessee bears all of the costs and expenses of operating the
senior living center, including the cost of any inventory used in
its operation, during the term of the lease, other than the cost
of certain furniture, fixtures and equipment, and certain capital
expenditures;
o the lessee benefits from any savings and bears the burdens of any
increases in the costs of operating the senior living center
during the term of the lease;
o in the event of damage or destruction to a senior living center,
the lessee is at economic risk because it will bear the economic
burden of the loss in income from operation of the senior living
center subject to the right, in certain circumstances, to
terminate the lease if the lessor does not restore the senior
living center to its prior condition;
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o the lessee has indemnified the Operating Partnership or the
applicable subsidiary against all liabilities imposed on the
Operating Partnership or the applicable subsidiary during the
term of the lease by reason of (A) injury to persons or damage to
property occurring at the senior living center or (B) the
lessee's use, management, maintenance or repair of the senior
living center;
o with regard to the minimum rent leases, the lessee is obligated
to pay, at a minimum, substantial base rent for the period of use
of the senior living center under the lease;
o the lessee stands to incur substantial losses or reap substantial
gains depending on how successfully it operates the senior living
center;
o ElderTrust and the Operating Partnership believe that each lessee
reasonably expected, at the times the leases were entered into,
to derive a meaningful profit, after expenses and taking into
account the risks associated with the lease, from the operation
of the senior living center during the term of its lease; and
o upon termination of each lease, the applicable senior living
center is expected to have a remaining useful life equal to at
least 20% of its expected useful life on the initial start date
of the lease, and a fair market value equal to at least 20% of
its fair market value on the initial start date of the lease.
Investors should be aware that there are no controlling Treasury
Regulations, published rulings or judicial decisions involving leases with terms
substantially the same as the percentage rent leases or the minimum rent leases
that discuss whether such leases constitute true leases for federal income tax
purposes. Therefore, there can be no assurance that the IRS might not assert a
contrary position.
If the leases were recharacterized as service contracts or partnership
agreements, rather than true leases, or disregarded altogether for tax purposes,
all or part of the payments that the Operating Partnership receives from the
lessees would not be considered rent or would not otherwise satisfy the various
requirements for qualification as "rents from real property." In that case,
ElderTrust likely would not be able to satisfy either the 75% or 95% gross
income tests and, as a result, would lose its REIT status.
In addition, for rents paid pursuant to the leases to qualify as "rents
from real property," the lessees must not be regarded as related party tenants.
A lessee of ElderTrust, including Genesis Health Ventures, Inc. and certain of
its subsidiaries, will be regarded as a related party tenant only if ElderTrust
and/or one or more actual or constructive owners of 10% or more of ElderTrust
actually or constructively own 10% or more of such lessee (including, with
regard to a Genesis lessee, through an ownership interest in Genesis).
ElderTrust's Declaration of Trust expressly prohibits any single
shareholder from owning, actually and/or constructively, more than (i) 8.6% of
ElderTrust's issued and outstanding common shares or (ii) 9.9% of the issued and
outstanding shares of any class or series of ElderTrust's preferred shares.
These prohibitions contains self-executing enforcement mechanisms.
Assuming that these prohibitions are enforced at all times (subject to any
waivers permitted under the Declaration of Trust), the lessees of ElderTrust
should not be regarded as related party tenants. There can be no assurance,
however, that these ownership restrictions will be enforced in accordance with
their terms in all circumstances or otherwise will ensure that the lessees will
not be regarded as related party tenants.
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As indicated above, "rents from real property" must not be based in
whole or in part on the income or profits of any person. Payments made pursuant
to ElderTrust's leases should qualify as "rents from real property" since they
are based on either fixed dollar amounts or on specified percentages of receipts
or sales fixed at the time the leases were entered into. The foregoing assumes
that the leases are not renegotiated during their term in a manner that has the
effect of basing either the percentage rent or base rent on income or profits.
The foregoing also assumes that the leases are not in reality used as a means of
basing rent on income or profits. More generally, the rent payable under the
leases will not qualify as "rents from real property" if, considering the leases
and all the surrounding circumstances, the arrangement does not conform with
normal business practice. ElderTrust has represented that it will not
renegotiate the percentages used to determine the percentage rent during the
terms of the leases in a manner that has the effect of basing rent on income or
profits. In addition, ElderTrust has represented that the rental provisions and
other terms of the leases conform with normal business practice and were not
intended to be used as a means of basing rent on income or profits. Furthermore,
ElderTrust has represented that, with respect to other properties that it
acquires in the future, it will not charge rent for any property that is based
in whole or in part on the income or profits of any person, except by reason of
being based on a fixed percentage of gross revenues, as described above.
ElderTrust leases certain items of personal property to the lessees in
connection with its leases. Under the Internal Revenue Code, if a lease provides
for the rental of both real and personal property and the portion of the rent
attributable to personal property is 15% or less of the total rent due under the
lease, then all rent paid pursuant to such lease qualifies as "rent from real
property." If, however, a lease provides for the rental of both real and
personal property, and the portion of the rent attributable to personal property
exceeds 15% of the total rent due under the lease, then no portion of the rent
that is attributable to personal property will qualify as "rent from real
property." Under the law in effect prior to January 1, 2001, the amount of rent
attributable to personal property was that amount which bore the same ratio to
total rent for the taxable year as the average of the adjusted tax bases of the
personal property at the beginning and end of the year bore to the average of
the aggregate adjusted tax bases of both the real and personal property at the
beginning and end of such year. For ElderTrust's taxable years beginning after
December 31, 2000, the personal property test is based on fair market value as
opposed to adjusted tax basis. ElderTrust has represented that, with respect to
each of its leases that includes a lease of items of personal property, either
the amount of rent attributable to personal property with respect to such lease
will not exceed 15% of the total rent due under the lease (determined under the
law in effect for the applicable period), or, with respect to leases where the
rent attributable to personal property constitutes non-qualifying income, such
amounts, when taken together with all other nonqualifying income earned by
ElderTrust, will not jeopardize ElderTrust's status as a REIT.
If any of the senior living centers or office buildings were to be
operated directly by the Operating Partnership or a subsidiary as a result of a
default by a lessee under the applicable lease, such senior living center would
constitute foreclosure property until the close of the third tax year following
the tax year in which it was acquired, or for up to an additional three years if
an extension is granted by the IRS, provided that:
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(1) the operating entity conducts operations through an independent
contractor (which might, but not necessarily in all circumstances,
include Genesis and its affiliates), within 90 days after the date the
property is acquired as the result of a default by a lessee;
(2) the operating entity does not undertake any construction on the
foreclosed property other than completion of improvements that were
more than 10% complete before default became imminent;
(3) foreclosure was not regarded as foreseeable at the time the
applicable lessor entered into such lease; and
(4) ElderTrust elects on its federal income tax return filed for the
year in which the foreclosure occurred to treat the property as
"foreclosure property."
For as long as such senior living center or office building constitutes
foreclosure property, the income from the property would be subject to tax at
the maximum corporate rates, but it would qualify under the 75% and 95% gross
income tests. However, if such property does not constitute foreclosure property
at any time in the future, income earned from the disposition or operation of
such property will not qualify under the 75% and 95% gross income tests. For
taxable years beginning after December 31, 2000, similar rules apply to treat as
foreclosure property qualified health care property acquired by a REIT as the
result of the termination of a lease of such property, except that such property
would constitute foreclosure property until the close of the second tax year
following the tax year in which it was acquired, or for up to an additional four
years if an extension is granted by the IRS.
Through the Operating Partnership, which is not an "independent
contractor," ElderTrust may provide certain services with respect to the senior
living centers and office buildings, but ElderTrust believes (and has
represented) that any such services that are "impermissible services" will be
provided through an independent contractor from whom ElderTrust derives no
revenue (except to the extent that the income derived from such impermissible
services would not exceed the 1% threshold described above or the Board of
Trustees otherwise determines, in its discretion, that the nonqualifying income
resulting therefrom is not material and will not jeopardize ElderTrust's status
as a REIT).
Except for interest on obligations secured by real property, "interest"
will not qualify under the 75% gross income test (but will qualify under the 95%
gross income test). For interest received from loans made or held by ElderTrust
to qualify for both the 75% and 95% gross income test, they must be secured by
real property and must be treated as debt for federal income tax purposes. In
this regard, each of the loans made by ElderTrust to third parties (including
Genesis and certain of its subsidiaries but excluding ET Capital Corp.) or
acquired by ElderTrust from Genesis in the past have been secured by real
property, ElderTrust has represented that the terms of each have been typical of
a debt instrument, and ElderTrust has represented that the fair market value of
the real property securing each of such loans exceeded the principal amount of
the loan at the time the loan was made by ElderTrust or, if acquired by
ElderTrust from Genesis, exceeded the principal amount of the loan at the time
it was made or acquired. Interest on loans, whether secured by real property or
not, that is based on the income or profits of any person will not qualify under
either the 75% or the 95% gross income test. However, interest will not fail to
qualify for purposes of the gross income tests solely by reason of being based
upon a fixed percentage or percentages of receipts or sales. ElderTrust has not
made and does not anticipate making any loans where interest payable is based
upon the income or profits of any person.
11
ElderTrust has received and expects to continue to receive interest
payments from ET Capital Corp. These amounts of interest are qualifying income
for purposes of the 95% gross income test but not the 75% gross income test.
ElderTrust does not anticipate that the amounts of interest derived from ET
Capital Corp. will affect its ability to continue to satisfy the 75% gross
income test.
ElderTrust also receives dividends from ET Capital Corp., and it could
realize capital gains with respect to its investment in ET Capital Corp. (either
due to distributions received from ET Capital Corp. or upon a disposition of
part or all of its interest in ET Capital Corp.). The Operating Partnership's
share of any dividends received from ET Capital Corp. or capital gains
recognized with respect thereto should qualify for purposes of the 95% gross
income test but not for purposes of the 75% gross income test. The Operating
Partnership does not anticipate that it will receive sufficient dividends from
ET Capital Corp. and/or capital gains with respect to ET Capital Corp. to cause
it to fail the 75% gross income test.
ElderTrust inevitably will have some gross income from various sources,
including the sources described in the preceding paragraphs, that fails to
constitute qualifying income for purposes of one or both of the 75% or 95% gross
income tests. Taking into account its actual and anticipated sources of
non-qualifying income, however, ElderTrust believes that its aggregate gross
income from all sources has satisfied, and ElderTrust believes that its
aggregate gross income will continue to satisfy, the 75% and 95% gross income
tests applicable to REITs for each taxable year commencing within the taxable
year ended December 31, 1998.
If ElderTrust were to fail to satisfy one or both of the 75% or 95%
gross income tests for any taxable year, it may nevertheless qualify as a REIT
for such year if it were entitled to relief under certain provisions of the
Internal Revenue Code. These relief provisions generally would be available if
ElderTrust's failure to meet such tests was due to reasonable cause and not due
to willful neglect, ElderTrust were to attach a schedule of the sources of its
income to its federal income tax return, and any incorrect information set forth
on the schedule was not due to fraud with intent to evade tax. It is not
possible, however, to state whether in all circumstances ElderTrust would be
entitled to the benefit of these relief provisions. If these relief provisions
were inapplicable to a particular set of circumstances involving ElderTrust,
ElderTrust would not qualify as a REIT. As discussed above under "--General,"
even if these relief provisions were to apply, a tax would be imposed with
respect to the excess net income.
Any gain realized by ElderTrust on the sale of any property held as
inventory or other property held primarily for sale to customers in the ordinary
course of business, including ElderTrust's share of any such gain realized by
the Operating Partnership, will be treated as income from a "prohibited
transaction" that is subject to a 100% penalty tax. Under existing law, whether
property is held as inventory or primarily for sale to customers in the ordinary
course of a trade or business is a question of fact that depends upon all the
facts and circumstances with respect to the particular transaction. The
Operating Partnership believes that it and its subsidiaries have held, and will
continue to hold, their properties for investment with a view to long-term
appreciation, will continue to engage in the business of acquiring and owning
senior living centers, and will make sales of their properties only as are
consistent with ElderTrust's investment objectives. There can be no assurance,
however, that the IRS might not contend that one or more of these sales is
subject to the 100% penalty tax.
12
ElderTrust provided a construction loan of up to approximately $6.4
million for the purpose of financing the development and construction of phase 1
of a condominium style independent living facility in 1998. If this loan were to
be recharacterized for tax purposes as an equity investment in the development
project, ElderTrust's income from such loan would be considered income from the
development and sale of the condominium units and would be subject to the 100%
penalty tax on "prohibited transactions." Whether a loan transaction should be
characterized as an equity investment for tax purposes depends upon all of the
surrounding facts and circumstances, including, among other things, the terms of
the loan, the collateral therefor and the financial circumstances of the
borrower and any guarantors. ElderTrust believes, based upon the terms of this
loan and its knowledge of the financial circumstances of the borrower and the
guarantor of the loan, that the loan should not be characterized as an equity
investment, but there can be no assurance that the Internal Revenue Service
might not contend otherwise. This loan was repaid in 2001.
Asset Tests Applicable to REITs
At the close of each quarter of its taxable year, ElderTrust must
satisfy the following four tests relating to the nature of its assets:
o First, at least 75% of the value of ElderTrust's total assets
must be represented by real estate assets and certain cash items.
ElderTrust's real estate assets include, for this purpose, its
allocable share of real estate assets held by the Operating
Partnership and the non-corporate subsidiaries of the Operating
Partnership, as well as stock or debt instruments held for less
than one year purchased with the proceeds of a stock offering or
a long-term (at least five years) debt offering of ElderTrust,
cash, cash items and government securities. ElderTrust's real
estate assets do not include stock or debt instruments (other
than mortgages) issued by its taxable REIT subsidiaries or their
subsidiaries.
o Second, no more than 25% of ElderTrust's total assets may be
represented by securities other than those in the 75% asset
class.
o Third, of the investments included in the 25% asset class, the
value of any one issuer's securities owned by ElderTrust may not
exceed 5% of the value of ElderTrust's total assets and
ElderTrust may not own more than 10% of either the outstanding
voting securities or the value of the outstanding securities of
any one issuer. For 2001 and later years, these limits do not
apply to securities of a taxable REIT subsidiary. For years prior
to 2001, the 10% limit applied only with respect to the voting
securities of any issuer and not to the value of the securities
of any issuer.
o Fourth, for taxable years beginning after December 31, 2000, not
more than 20% of the value of ElderTrust's total assets may be
represented by securities of taxable REIT subsidiaries.
For years prior to 2001, the Operating Partnership did not own any of
the voting stock of ET Capital Corp. but it did own 100% of the nonvoting stock
and a note of ET Capital Corp. Effective January 1, 2001, ET Capital Corp.
elected to be treated as a taxable REIT subsidiary of ElderTrust. Neither
ElderTrust, the Operating Partnership, nor any of the non-corporate subsidiaries
of the Operating Partnership has owned or currently intends to own more than 10%
of the voting securities of any entity that is treated as a corporation for
federal income tax purposes, except for, with regard to periods beginning after
December 31, 2000, corporations or other entities that qualify and elect to be
treated as taxable REIT subsidiaries or other REITs. In addition, ElderTrust
believes that the value of the securities of any one issuer owned by ElderTrust,
the Operating Partnership, or any of the non-corporate subsidiaries of the
Operating Partnership, including ElderTrust's pro rata share of the value of the
securities of ET Capital Corp., has not exceeded five percent of the total value
of ElderTrust's assets for years prior to January 1, 2001, and ElderTrust has
not exceeded and intends not to exceed that percentage threshold in subsequent
years unless the issuer is a taxable REIT subsidiary. There can be no assurance,
however, that the IRS might not contend that the value of such securities
exceeded in the past or currently exceeds one or more of the value limitations
or that, for years prior to 2001, the nonvoting stock of ET Capital Corp. should
have been considered "voting stock" for this purpose.
13
After initially meeting the asset tests at the close of any quarter,
ElderTrust will not lose its status as a REIT for failure to satisfy the asset
tests at the end of a later quarter solely by reason of changes in asset values.
If the failure to satisfy the asset tests results from an acquisition of
securities or other property during a quarter, the failure can be cured by the
disposition of sufficient nonqualifying assets within 30 days after the close of
that quarter. An example of such an acquisition would be an increase in
ElderTrust's interest in the Operating Partnership as a result of the exercise
of a limited partner's unit redemption right or an additional capital
contribution of proceeds from an offering of shares of beneficial interest by
ElderTrust. ElderTrust has monitored and currently intends to continue to
monitor its compliance with the asset tests and to take such actions within 30
days after the close of any quarter, to the extent reasonably practicable, as
may be required to cure any noncompliance. If ElderTrust fails to cure
noncompliance with the asset tests within such time period, ElderTrust would
cease to qualify as a REIT.
As discussed above, the assets held by ElderTrust have historically
included loans made to third parties, including Genesis and certain of its
subsidiaries. For these loans to qualify as "real estate assets" for the purpose
of the asset tests, they must have been secured by real property and treated as
debt for federal income tax purposes. As discussed above, all of ElderTrust's
loans to third parties have been secured by real property, ElderTrust has
represented that the terms of each have been typical of a debt instrument and
ElderTrust has represented that the fair market value of the real property
securing each of such loans exceeded the principal amount of the loan or at the
time it was made.
Qualification of an Entity as a Taxable REIT Subsidiary
To qualify as a "taxable REIT subsidiary," an entity must be taxable as
a corporation and must satisfy the following additional requirements:
o a REIT must own stock in the entity, whether directly or
indirectly;
o the entity must elect, together with the REIT that owns stock in
it, to be treated as a taxable REIT subsidiary under the Code;
and
14
o the entity must not directly or indirectly operate or manage a
lodging or health care facility or, generally, provide to another
person, under a franchise, license or otherwise, rights to any
brand name under which any lodging facility or health care
facility is operated.
Certain restrictions imposed on taxable REIT subsidiaries are intended
to ensure that such entities will be subject to an appropriate level of federal
income taxation. First, a taxable REIT subsidiary may not deduct interest
payments made in any year to an affiliated REIT to the extent that such payments
exceed, generally, 50% of the taxable REIT subsidiary's adjusted taxable income
for that year (although the taxable REIT subsidiary may carry forward to, and
deduct in, a succeeding year the disallowed interest amount if the 50% test is
satisfied). In addition, if a taxable REIT subsidiary pays interest, rent or
another amount to a REIT that exceeds the amount that would be paid to an
unrelated party in an arm's length transaction, the REIT may be subject to an
excise tax equal to 100% of such excess. One of ElderTrust's taxable REIT
subsidiaries, ET Capital Corp., has made and will continue to make interest and
other payments to ElderTrust. There can be no assurance that the limitation on
interest deductions applicable to taxable REIT subsidiaries will not apply to
the interest payments made to ElderTrust by ET Capital Corp., resulting in an
increase in the corporate tax liability of such subsidiary. Moreover, there can
be no assurance that the terms establishing the payments made by ET Capital
Corp. to ElderTrust will not result in the imposition of the 100% excise tax to
a portion of any such payment.
Annual Distribution Requirements Applicable to REITs
To be taxed as a REIT, ElderTrust is required to distribute dividends,
other than capital gain dividends, to its shareholders in an amount at least
equal to
(i) the sum of (a) 90% of its "REIT taxable income," computed without
regard to the dividends paid deduction and ElderTrust's net capital
gain, and (b) 90% of the net income, after tax, if any, from
foreclosure property, minus
(ii) the sum of certain items of noncash income.
For years prior to 2001, the applicable distribution percentage was 95%
rather than 90%.
Such distributions generally must be paid in the taxable year to which
they relate. Dividends may be paid in the following taxable year in two
circumstances. First, dividends may be declared in the following taxable year if
declared before ElderTrust timely files its tax return for such year and if paid
on or before the first regular dividend payment date after such declaration.
Second, if ElderTrust declares a dividend in October, November or December of
any year with a record date in one of those months and pays the dividend on or
before January 31 of the following year, ElderTrust will be treated as having
paid the dividend on December 31 of the year in which the dividend was declared.
The Operating Partnership's partnership agreement authorizes ElderTrust, as
general partner, to take such steps as may be necessary to cause the Operating
Partnership to distribute to its partners an amount sufficient to permit
ElderTrust to meet its distribution requirements.
15
To the extent that ElderTrust does not distribute all of its net
capital gain or distributes at least 90%, but less than 100%, of its "REIT
taxable income" within the periods described in the prior paragraph, it is
subject to income tax thereon at regular capital gain and ordinary corporate tax
rates. ElderTrust, however, may designate some or all of its retained net
capital gain, so that, although the designated amount will not be treated as
distributed for purposes of this tax, a shareholder would include its
proportionate share of such amount in income, as capital gain, and would be
treated as having paid its proportionate share of the tax paid by ElderTrust
with respect to such amount. The shareholder's basis in its shares of ElderTrust
would be increased by the amount the shareholder included in income and
decreased by the amount of the tax the shareholder is treated as having paid.
ElderTrust would make an appropriate adjustment to its earnings and profits. For
a more detailed description of the federal income tax consequences to a
shareholder of such a designation, see "--Taxation of Taxable U.S. Shareholders
Generally" below.
It is possible, because of differences in timing between ElderTrust's
recognition of taxable income and its receipt of cash available for
distribution, that ElderTrust, from time to time, may not have sufficient cash
or other liquid assets to meet its distribution requirements. In such event, in
order to meet the distribution requirements, ElderTrust may find it necessary to
arrange for short-term, or possibly long-term, borrowings to fund required
distributions and/or to pay dividends in the form of taxable stock dividends.
During 2000, ElderTrust recorded significant bad debt expenses related
to loans and properties under lease as a result of the bankruptcy filing by
Genesis, and, consequently, recognized a net loss for financial reporting
purposes. For federal income tax purposes, these losses totaling approximately
$13.5 million were recognized in 2001. These losses offset all of ElderTrust's
taxable income for 2001 and 2002 and resulted in a net operating loss ("NOL")
carryforward to ElderTrust's 2003 taxable year and, potentially, subsequent
taxable years. This NOL carryforward can be applied to offset income in
ElderTrust's 2003 and, potentially, subsequent taxable years, thereby reducing
or eliminating the amounts required to be distributed by ElderTrust in those
years. An NOL of a REIT in any given year may be carried forward until utilized
but over no more than 20 years.
NOL deductions may be subject to various limitations. The general
limitation is that the deduction is limited to the current year regular taxable
income computed without regard to the loss deduction. For alternative minimum
tax purposes, the general limitation is equal to 90% of the current year
"alternative minimum taxable income" computed without regard to the loss
deduction. The applicable REIT distribution percentage requirement is applied
against the greater of regular or alternative minimum taxable income. The 2002
Job Creation and Worker Assistance Act allows NOL deductions attributable to NOL
carryforwards arising in taxable years ending in 2001 and 2002 to offset 100%
(instead of 90%) of alternative minimum taxable income. Other limitations
include, but are not limited to, those imposed for a greater than 50% ownership
change among ElderTrust's "five percent" and greater owners during a test
period, which is generally a three year period ending on each date there is a
change in the ownership of ElderTrust's shares held by a "five percent" or
greater owner. ElderTrust believes that there has been no such "ownership
change" to date that would cause this limitation to apply, but there can be no
assurance that an "ownership change" will not occur in future years.
Effective for the quarter ended September 30, 2000, ElderTrust
suspended its quarterly distributions. No distributions were made for the years
ended December 31, 2001 or 2002. Based on the amount of the losses described
above, ElderTrust does not believe it was required to make any distributions to
its shareholders for REIT qualification purposes for those years. On December 4,
2002, ElderTrust issued a press release addressing the dividend distribution
policy. ElderTrust stated that it intends to resume regular quarterly
distributions to the holders of its common shares and that the initial
distribution is expected to be declared in mid-April 2003. Distributions by
ElderTrust are at the discretion of its board of trustees.
16
ElderTrust calculates its "REIT taxable income" based upon the
conclusion that each non-corporate subsidiary of the Operating Partnership
holding a property or the Operating Partnership itself, as applicable, is the
owner of its properties for federal income tax purposes. As a result, ElderTrust
expects that the depreciation deductions with respect to its properties will
reduce its "REIT taxable income." This conclusion is consistent with the
conclusion above that the leases of ElderTrust's properties have been and will
continue to be treated as true leases for federal income tax purposes. If,
however, the IRS were to challenge successfully this position, in addition to
failing in all likelihood the 75% and 95% gross income tests described above,
ElderTrust also might be deemed retroactively to have failed to meet the REIT
distribution requirements and would have to rely on the payment of a "deficiency
dividend" in order to retain its REIT status.
Under certain circumstances, ElderTrust may be able to rectify a
failure to meet the distribution requirement for a year by paying "deficiency
dividends" to shareholders in a later year, which may be included in
ElderTrust's deduction for dividends paid for the earlier year. Thus, ElderTrust
may be able to avoid being taxed on amounts distributed as deficiency dividends;
however, ElderTrust would be required to pay to the IRS interest based upon the
amount of any deduction taken for deficiency dividends.
Furthermore, if ElderTrust should fail to distribute during each
calendar year at least the sum of 85% of its REIT ordinary income for such year,
95% of its REIT capital gain income for such year, and any undistributed taxable
income from prior periods, it would be subject to an excise tax. The excise tax
would equal 4% of the excess of such required distribution over the sum of
amounts actually distributed and amounts retained with respect to which the REIT
pays federal income tax.
Failure of ElderTrust to Qualify as a REIT
If ElderTrust were to fail to qualify for taxation as a REIT in any
taxable year, and if the relief provisions were not to apply, ElderTrust would
be subject to tax, including any applicable alternative minimum tax, on its
taxable income at regular corporate rates. Distributions to shareholders in any
year in which ElderTrust were to fail to qualify would not be deductible by
ElderTrust nor would they be required to be made. As a result, ElderTrust's
failure to qualify as a REIT would significantly reduce the cash available for
distribution by ElderTrust to its shareholders and could materially reduce the
value of its shares. In addition, if ElderTrust were to fail to qualify as a
REIT, all distributions to shareholders would be taxable as ordinary income, to
the extent of ElderTrust's current and accumulated E&P, although, subject to
certain limitations of the Internal Revenue Code, corporate distributees may be
eligible for the dividends received deduction with respect to these
distributions. Unless entitled to relief under specific statutory provisions,
ElderTrust also would be disqualified from taxation as a REIT for the four
taxable years following the year during which qualification was lost. It is not
possible to state whether in all circumstances ElderTrust would be entitled to
such statutory relief.
17
Tax Aspects of ElderTrust's Ownership of Interests in the Operating Partnership
General
Substantially all of ElderTrust's investments are held through the
Operating Partnership, which holds the properties either directly or through
certain subsidiaries. In general, partnerships are "pass-through" entities that
are not subject to federal income tax. Rather, partners are allocated their
proportionate shares of the items of income, gain, loss, deduction and credit of
a partnership, and are potentially subject to tax thereon, without regard to
whether the partners receive a distribution from the partnership. ElderTrust
includes in its income its proportionate share of the foregoing partnership
items for purposes of the various REIT income tests and in the computation of
its REIT taxable income. Moreover, for purposes of the REIT asset tests,
ElderTrust includes its proportionate share of assets held through the Operating
Partnership and those of its subsidiaries that are either disregarded as
separate entities or treated as partnerships for tax purposes. See "--Federal
Income Taxation of ElderTrust--Ownership of Partnership Interests by a REIT"
above.
Entity Classification
If the Operating Partnership or any non-corporate subsidiary were
treated as an association, the entity would be taxable as a corporation and
therefore would be subject to an entity level tax on its income. In such a
situation, the character of ElderTrust's assets and items of gross income would
change and could preclude ElderTrust from qualifying as a REIT (see "--Federal
Income Taxation of ElderTrust--Asset Tests Applicable to REITs" and "--Income
Tests Applicable to REITs" above).
The entire discussion set forth herein of the tax treatment of
ElderTrust and the federal income tax consequences of the ownership of common
shares of beneficial interest of ElderTrust is based on the assumption that the
Operating Partnership and all of its subsidiaries (other than ET Capital Corp.)
are classified as partnerships or disregarded as separate entities for federal
income tax purposes. Pursuant to regulations under Section 7701 of the Internal
Revenue Code, a partnership will be treated as a partnership for federal income
tax purposes unless it elects to be treated as a corporation or would be treated
as a corporation because it is a "publicly traded partnership."
Neither the Operating Partnership nor any of its non-corporate
subsidiaries has elected or will elect to be treated as a corporation.
Therefore, subject to the disclosure below, the Operating Partnership and each
such subsidiary will be treated as a partnership for federal income tax purposes
(or, if such an entity has only one partner or member, disregarded entirely for
federal income tax purposes).
Pursuant to Section 7704 of the Internal Revenue Code, a partnership
that does not elect to be treated as a corporation nevertheless will be treated
as a corporation for federal income tax purposes if it is a "publicly traded
partnership" and it does not derive at least 90% of its income from certain
specified sources of "qualifying income" within the meaning of that section. A
"publicly traded partnership" is any partnership (i) the interests in which are
traded on an established securities market or (ii) the interests in which are
readily tradable on a "secondary market or the substantial equivalent thereof."
Units of limited partner interest in the Operating Partnership, or "OP Units,"
will not be traded on an established securities market. There is a significant
risk, however, that the OP Units could be considered readily tradable on the
substantial equivalent of a secondary market. In that event, the Operating
Partnership could be treated as a "publicly traded partnership," but even then
it would only be taxable as a corporation if less than 90% of its gross income
were to constitute "qualifying income." Treasury Regulations under Section 7704
of the Internal Revenue Code set forth certain "safe harbors" under which
interests will not be treated as "readily tradable on a secondary market (or the
substantial equivalent thereof)" within the meaning of Section 7704.
18
For purposes of determining whether the "qualifying income" exception
is satisfied, the income requirements generally applicable to REITs and the
definition of "qualifying income" under Section 7704 of the Internal Revenue
Code are similar in most key respects. There is one significant difference,
however. For a REIT, rent from a tenant does not qualify as "rents from real
property" if the REIT and/or one or more actual or constructive owners of 10% or
more of the REIT actually or constructively own 10% or more of the tenant
(subject to an exception for rents from a tenant that is a taxable REIT
subsidiary). Under Section 7704 of the Internal Revenue Code, rent from a tenant
is not qualifying income if a partnership and/or one or more actual or
constructive owners of 5% or more of the partnership actually or constructively
own 10% or more of the tenant. ElderTrust believes that it has satisfied the
"qualifying income" exception for each of its taxable years, beginning with the
taxable year ended December 31, 1998, and will satisfy the exception for future
years.
If the Operating Partnership were taxable as a corporation, most, if
not all, of the tax consequences described herein would be inapplicable. In
particular, ElderTrust would not qualify as a REIT because the value of
ElderTrust's ownership interest in the Operating Partnership would exceed five
percent of ElderTrust's assets and ElderTrust would be considered to hold more
than 10% of the voting securities (and 10% of the value of the outstanding
securities) of another corporation (see "--Federal Income Taxation of
ElderTrust--Asset Tests Applicable to REITs" above). In this event, the value of
ElderTrust's common shares could be adversely affected (see "--Federal Income
Taxation of ElderTrust--Failure of ElderTrust to Qualify as a REIT" above).
Allocations of Operating Partnership Income, Gain, Loss and Deduction
Although a partnership agreement will generally determine the
allocation of income and loss among partners, such allocations will be
disregarded for tax purposes if they do not comply with the provisions of
Section 704(b) of the Internal Revenue Code and the applicable regulations.
Generally, Section 704(b) and the applicable regulations require that
partnership allocations respect the economic arrangement of the partners.
If an allocation is not recognized for federal income tax purposes, the
item subject to the allocation will be reallocated in accordance with the
partners' interests in the partnership, which will be determined by taking into
account all of the facts and circumstances relating to the economic arrangement
of the partners with respect to such item. The allocations of taxable income and
loss provided for in the Operating Partnership partnership agreement and the
partnership agreements and operating agreements of the non-corporate
subsidiaries are intended to comply with the requirements of Section 704(b) of
the Internal Revenue Code and the regulations promulgated thereunder.
19
Tax Allocations with Respect to Contributed Properties
The Operating Partnership received contributions of appreciated
property at the time of, and in connection with, the Offering. Pursuant to
Section 704(c) of the Internal Revenue Code, income, gain, loss and deduction
attributable to appreciated or depreciated property that is contributed to a
partnership in exchange for an interest in the partnership must be allocated in
a manner such that the contributing partner is charged with, or benefits from,
respectively, the difference between the adjusted tax basis and the fair market
value of such property at the time of contribution associated with the property
at the time of the contribution. This difference is known as "built-in gain."
The Operating Partnership agreement requires that such allocations be made in a
manner consistent with Section 704(c) of the Internal Revenue Code. In general,
the partners of the Operating Partnership who contributed depreciated assets
having built-in gain are allocated depreciation deductions for tax purposes that
are lower than such deductions would be if determined on a pro rata basis. In
addition, in the event of the disposition of any of the contributed assets which
have built-in gain, all income attributable to the built-in gain generally will
be allocated to the contributing partners, even though the proceeds of such sale
would be allocated proportionately among all the partners and likely would be
retained by the Operating Partnership, rather than distributed. These
allocations will tend to eliminate the built-in gain over the life of the
Operating Partnership. However, the special allocation rules of Section 704(c)
of the Internal Revenue Code do not always eliminate entirely the built-in gain
on an annual basis or with respect to a specific taxable transaction, such as a
sale. Thus, the carryover basis of the contributed assets in the hands of the
Operating Partnership may cause ElderTrust to be allocated lower depreciation
and other deductions and, in the event of a sale of such contributed assets,
possibly an amount of taxable income in excess of the economic or book income
allocated to it. Such an allocation may cause ElderTrust to recognize taxable
income in excess of cash proceeds, which might adversely affect ElderTrust's
ability to comply with the REIT distribution requirements.
The Operating Partnership and ElderTrust have determined to use the
"traditional method" to account for built-in gain with respect to the properties
contributed to the Operating Partnership in connection with the Offering. This
method is generally a more favorable method for accounting for built-in gain
from the perspective of those partners who received OP Units in exchange for
property with a low basis relative to value at the time of the Offering, and is
a less favorable method from the perspective of those partners who contributed
cash or "high basis" assets to the Operating Partnership, including ElderTrust,
which contributed cash proceeds from the Offering to the Operating Partnership.
Any property purchased by the Operating Partnership will initially have
a tax basis equal to its fair market value, and Section 704(c) of the Internal
Revenue Code will not apply.
The Operating Partnership specially allocates depreciation deductions
and low income housing tax credits of, and gain attributable to, three of its
properties to the holders of its Class C partnership units. ElderTrust and its
shareholders will not share an interest in these items to the extent that they
are so allocated to the Class C unitholders.
20
Other Tax Consequences for ElderTrust and Its Shareholders
ElderTrust and its shareholders are subject to state or local taxation
in various state or local jurisdictions, including those in which the Operating
Partnership or ElderTrust's shareholders transact business or reside. The state
and local tax treatment of ElderTrust and its shareholders may not conform to
the federal income tax consequences discussed above. Consequently, prospective
shareholders of ElderTrust should consult their own tax advisors regarding the
effect of state and local tax laws on an investment in ElderTrust.
A portion of the cash to be used by ElderTrust to fund distributions
comes from dividends from ET Capital Corp. and, in some cases, interest on notes
of ET Capital Corp. held by the Operating Partnership. ET Capital Corp. is
subject to federal, state and local income tax at the full applicable corporate
rates. To the extent that ET Capital Corp. is required to pay federal, state or
local taxes, ElderTrust will receive less dividend income and will have less
cash available for distribution to shareholders.
As described above in "--Federal Income Taxation of
ElderTrust--Qualification of an Entity as a Taxable REIT Subsidiary," ET Capital
Corp. is fully taxable as a corporation and is subject to certain rules intended
to restrict its ability to reduce its tax liability.
Taxation of Taxable U.S. Shareholders Generally
The term "U.S. shareholder," when used in this discussion, means a
holder of shares of beneficial interest who is, for United States federal income
tax purposes:
o a citizen or resident of the United States,
o a corporation, partnership, or other entity treated as a
corporation or partnership for United States federal income tax
purposes, created or organized in or under the laws of the United
States or of a state hereof or in the District of Columbia,
unless, in the case of a partnership, Treasury Regulations
provide otherwise,
o an estate the income of which is subject to United States federal
income taxation regardless of its source, or
o a trust whose administration is subject to the primary
supervision of a United States court and which has one or more
United States persons who have the authority to control all
substantial decisions of the trust.
Notwithstanding the preceding sentence, to the extent provided in
Treasury Regulations, some trusts in existence on August 20, 1996, and treated
as United States persons prior to this date that elect to continue to be treated
as United States persons, shall also be considered U.S. shareholders. Generally,
in the case of a partnership that holds common shares, any partner that would be
a U.S. shareholder if it held the shares directly is also a U.S. shareholder.
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Distributions Generally
Distributions (or deemed distributions) made by ElderTrust out of its
current or accumulated E&P, other than capital gain dividends or retained
capital gains as discussed below, constitute dividends taxable to its taxable
U.S. shareholders as ordinary income. As long as ElderTrust qualifies as a REIT,
such distributions are not eligible for the dividends received deduction that is
generally afforded to U.S. shareholders that are corporations. To the extent
that ElderTrust makes distributions not designated as capital gain dividends in
excess of its current and accumulated E&P, such distributions are treated first
as a tax-free return of capital to each U.S. shareholder, reducing the adjusted
basis which such U.S. shareholder has in its common stock for tax purposes by
the amount of such distribution, but not below zero, with distributions in
excess of such U.S. shareholder's adjusted basis taxable as capital gains,
provided that the common shares have been held as a capital asset. ElderTrust
will notify shareholders after the close of its taxable year as to the portions
of distributions attributable to that year that constitute ordinary income,
return of capital and capital gain.
Dividends declared by ElderTrust in October, November or December of
any year and payable to a shareholder of record on a specified date in any such
month are treated as both paid by ElderTrust and received by the shareholder on
December 31 of such year, provided that the dividend is actually paid by
ElderTrust on or before January 31 of the following year.
For purposes of computing liability for alternative minimum tax,
certain of ElderTrust's alternative minimum tax adjustments may be treated as
alternative minimum tax adjustments of its shareholders in the ratio that
ElderTrust's distributions bear to its taxable income (determined without regard
to the deduction for dividends paid). Amounts treated as alternative minimum tax
adjustments of ElderTrust's shareholders would be deemed to be derived by the
shareholders proportionately from each such alternative minimum tax adjustment
of ElderTrust and would be taken into account by the shareholders in computing
their alternative minimum taxable income for the taxable year to which the
dividends are attributable.
Capital Gain Distributions; Retained Net Capital Gains
Distributions that ElderTrust properly designates as capital gain
dividends are taxable to taxable U.S. shareholders as gain from the sale or
exchange of a capital asset held for more than one year (without regard to the
period for which such taxable U.S. shareholder has held his common shares) to
the extent that they do not exceed ElderTrust's actual net capital gain for the
taxable year. A U.S. shareholder's share of a capital gain dividend is an amount
which bears the same ratio to the total amount of dividends paid to such U.S.
shareholder for the year as the aggregate amount designated as a capital gain
dividend bears to the aggregate amount of all dividends paid on all classes of
shares of beneficial interest for the year.
If ElderTrust designates any portion of a dividend as a capital gain
dividend, a U.S. shareholder will receive an Internal Revenue Service Form 1099
- - DIV indicating the amount that will be taxable to the shareholder as capital
gain. A portion of capital gain dividends received by noncorporate taxpayers may
be subject to tax at a 25% rate to the extent attributable to certain gains
realized on the sale of real property. In addition, noncorporate taxpayers are
generally taxed at a maximum rate of 20% on net long-term capital gain
(generally, the excess of net long-term capital gain over net short-term capital
loss) attributable to gains realized on the sale of property held for greater
than one year.
With regard to ElderTrust's taxable corporate U.S. shareholders,
distributions made by ElderTrust that are properly designated by it as capital
gain dividends will be taxable as long-term gain, at a maximum rate of 35%, to
the extent that they do not exceed ElderTrust's actual net capital gain for the
taxable year and without regard to the period during which such corporate U.S.
shareholder has held its common shares. Such U.S. shareholders may, however, be
required to treat up to 20% of certain capital gain dividends as ordinary
income.
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ElderTrust may designate, by written notice to its shareholders, that
it is treating all or a portion of its retained net capital gain as having been
distributed to its shareholders for tax purposes, even though no actual
distribution of such retained gain has been made. With respect to any such
retained net capital gains, a U.S. shareholder would include its proportionate
share of such gain in income as long-term capital gain and would be treated as
having paid its proportionate share of the tax actually paid by ElderTrust with
respect to the gain. The U.S. shareholder's basis in its common shares would be
increased by its share of such gain and decreased by its share of such tax. With
respect to such long-term capital gain of a U.S. shareholder that is an
individual or an estate or trust, a special 25% rate will apply generally to the
portion of the long-term capital gains of an individual or an estate or trust
attributable to deductions for depreciation taken with respect to depreciable
real property ("unrecaptured Section 1250 gain"). Shareholders are advised to
consult with their own tax advisors with respect to their capital gain tax
liability.
ElderTrust's Losses; Investment Interest Limitation
U.S. shareholders may not include in their income tax returns the net
operating losses or capital losses of ElderTrust. Instead, such losses will be
carried over by ElderTrust for potential offset against future income, subject
to certain limitations. Distributions made by ElderTrust and gain arising from
the sale or exchange by a U.S. shareholder of common shares will not be treated
as passive activity income, and, as a result, U.S. shareholders generally will
not be able to apply any "passive losses" against such income or gain.
Taxable dividend distributions from ElderTrust generally will be
treated as investment income for purposes of the "investment interest
limitation." This limitation provides that a non-corporate U.S. shareholder may
deduct as an itemized deduction in any taxable year only the amount of interest
incurred in connection with property held for investment that does not exceed
the excess of the shareholder's investment income over his or her investment
expenses for that year. Capital gain dividends and capital gains from the
disposition of shares, including distributions treated as such, will be treated
as investment income only if the non-corporate U.S. shareholder so elects, in
which case such capital gains will be taxed at ordinary income rates.
Dispositions of Common Shares
Upon any sale or other disposition of common shares, a U.S. shareholder
will recognize gain or loss for federal income tax purposes in an amount equal
to the difference between (i) the amount of cash and the fair market value of
any property received on such sale or other disposition and (ii) the holder's
adjusted basis in such common shares for tax purposes. Such gain or loss will be
capital gain or loss if the common shares have been held by the U.S. shareholder
as a capital asset. In the case of a U.S. shareholder who is an individual or an
estate or trust, such gain or loss will be long-term capital gain or loss, if
such shares have been held for more than one year, and any such long-term
capital gain will be subject to the maximum capital gain rate of 20%. U.S.
shareholders that acquire or are deemed to acquire the common shares after
December 31, 2000 and who hold the common shares for more than five years and
certain low income taxpayers may be eligible for a reduction in the long-term
capital gains rate. However, a maximum rate of 25% will apply to capital gain
that is treated as "unrecaptured Section 1250 gain" for individuals, trusts and
estates. The IRS has the authority to prescribe, but has not yet prescribed,
regulations on how the capital gain rates will apply to sales of shares of
REITs; accordingly, shareholders are urged to consult with their own tax
advisors with respect to their capital gain liability. In the case of a U.S.
shareholder that is a corporation, gain or loss from the sale of shares of
ElderTrust will be long-term capital gain or loss if such shares have been held
for more than one year, and any such capital gain shall be subject to the
maximum capital gain rate of 35%. In general, any loss recognized by a U.S.
shareholder upon the sale or other disposition of common shares that have been
held for six months or less, after applying certain holding period rules, will
be treated as a long-term capital loss, to the extent of distributions received
by such U.S. shareholder from ElderTrust that were required to be treated as
long-term capital gains.
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Backup Withholding for ElderTrust's Distributions
ElderTrust reports to its U.S. shareholders and the IRS the amount of
dividends paid during each calendar year and the amount of tax withheld, if any.
Under the backup withholding rules, a U.S. shareholder may be subject to backup
withholding at the rate of 30% (currently scheduled to be reduced to 28% by
2006) with respect to dividends paid unless such holder either is a corporation
or comes within certain other exempt categories and, when required, demonstrates
this fact, or provides a taxpayer identification number, certifies as to no loss
of exemption from backup withholding and otherwise complies with applicable
requirements of the backup withholding rules. A U.S. shareholder that does not
provide ElderTrust with a correct taxpayer identification number may also be
subject to penalties imposed by the IRS. Any amount paid as backup withholding
is creditable against the shareholder's income tax liability. In addition,
ElderTrust may be required to withhold a portion of its capital gain
distributions to any U.S. shareholders who fail to certify their non-foreign
status to ElderTrust. See "--Taxation of Non-U.S. Shareholders" below.
Taxation of Tax-Exempt Shareholders
Provided that a tax-exempt shareholder has not held its common shares
as "debt financed property" within the meaning of the Internal Revenue Code and
such shares are not otherwise used in a trade or business, the dividend income
from ElderTrust will not be unrelated business taxable income ("UBTI") to a
tax-exempt shareholder. Similarly, income from the sale of common shares will
not constitute UBTI unless such tax-exempt shareholder has held such common
shares as "debt financed property" within the meaning of the Internal Revenue
Code or has used the common shares in a trade or business.
However, for a tax-exempt shareholder that is a social club, voluntary
employee benefit association, supplemental unemployment benefit trust or
qualified group legal services plan exempt from federal income taxation under
Internal Revenue Code Sections 501 (c)(7), (c)(9), (c)(17) and (c)(20),
respectively, income from an investment in ElderTrust will constitute UBTI
unless the organization is properly able to deduct amounts set aside or placed
in reserve for certain purposes so as to offset the income generated by its
investment in ElderTrust. Such a prospective shareholder should consult its own
tax advisors concerning these "set aside" and reserve requirements.
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Notwithstanding the above, however, a portion of the dividends paid by
a "pension held REIT" shall be treated as UBTI as to any trust that is described
in Section 401(a) of the Internal Revenue Code, is tax-exempt under Section
501(a) of the Internal Revenue Code and holds more than 10%, by value, of the
interests in the REIT. Tax-exempt pension funds that are described in Section
401(a) of the Internal Revenue Code are referred to below as "qualified trusts."
A REIT is a "pension held REIT" if it meets the following two tests:
o The REIT would not have qualified as a REIT but for the fact that
Section 856(h)(3) of the Internal Revenue Code provides that
stock owned by qualified trusts shall be treated, for purposes of
the "not closely held" requirement, as owned by the beneficiaries
of the trust rather than by the trust itself.
o Either at least one such qualified trust holds more than 25%, by
value, of the interests in the REIT, or one or more such
qualified trusts, each of which owns more than 10%, by value, of
the interests in the REIT, hold in the aggregate more than 50%,
by value, of the interests in the REIT.
The percentage of any REIT dividend treated as UBTI is equal to the
ratio of the UBTI earned by the REIT, treating the REIT as if it were a
qualified trust and therefore subject to tax on UBTI, to the total gross income
of the REIT. A de minimis exception applies where the percentage is less than
five percent for any year. As discussed above, the provisions requiring
qualified trusts to treat a portion of REIT distributions as UBTI will not apply
if the REIT is able to satisfy the "not closely held" requirement without
relying upon the "look-through" exception with respect to qualified trusts.
Based on the current estimated ownership of ElderTrust's common shares and as a
result of certain limitations on transfer and ownership of common shares
contained in ElderTrust's Declaration of Trust, ElderTrust should not be
classified as a "pension held REIT."
Taxation of Non-U.S. Shareholders
The rules governing federal income taxation of the ownership and
disposition of common shares by non-U.S. shareholders (that is, shareholders who
are not "U.S. shareholders" as defined above) are complex and no attempt is made
herein to provide more than a brief summary of such rules. Accordingly, the
discussion does not address all aspects of federal income tax and does not
address any state, local or foreign tax consequences that may be relevant to a
non-U.S. shareholder in light of its particular circumstances. In addition, this
discussion is based on current law, which is subject to change, and assumes that
ElderTrust qualifies for taxation as a REIT. Prospective non-U.S. shareholders
should consult with their own tax advisers to determine the impact of federal,
state, local and foreign income tax laws with regard to an investment in
ElderTrust's common shares, including any reporting requirements.
Distributions Generally
Distributions (or deemed distributions) by ElderTrust to a non-U.S.
shareholder that are neither attributable to gain from sales or exchanges by
ElderTrust of United States real property interests nor designated by ElderTrust
as capital gain dividends or retained capital gains will be treated as dividends
of ordinary income to the extent that they are made out of current or
accumulated E&P of ElderTrust. Such distributions ordinarily will be subject to
withholding of United States federal income tax on a gross basis (that is,
without allowance of deductions) at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty, unless the dividends are treated
as effectively connected with the conduct by the non-U.S. shareholder of a
United States trade or business. Under certain treaties, however, lower
withholding rates generally applicable to dividends do not apply to dividends
from a REIT, such as ElderTrust. Certain certification and disclosure
requirements must be satisfied to be exempt from withholding under the
effectively connected income exemption. Dividends that are effectively connected
with such a trade or business will be subject to tax on a net basis (that is,
after allowance of deductions) at graduated rates, in the same manner as U.S.
shareholders are taxed with respect to such dividends, and are generally not
subject to withholding. Any such dividends received by a non-U.S. shareholder
that is a corporation may also be subject to an additional branch profits tax at
a 30% rate or such lower rate as may be specified by an applicable income tax
treaty. ElderTrust expects to withhold United States income tax at the rate of
30% on any distribution made to a non-U.S. shareholder unless (i) a lower treaty
rate applies and any required form or certification evidencing eligibility for
that lower rate is filed with ElderTrust or (ii) a non-U.S. shareholder files an
IRS Form W-8ECI with ElderTrust claiming that the distribution is effectively
connected income.
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Distributions in excess of the current or accumulated E&P of ElderTrust
will not be taxable to a non-U.S. shareholder to the extent that they do not
exceed the adjusted basis of the shareholder's common shares, but rather will
reduce the adjusted basis of such common shares. Such distributions, however,
will be subject to U.S. withholding tax as described below. To the extent that
such distributions exceed the adjusted basis of a non-U.S. shareholder's common
shares, they will give rise to gain from the sale or exchange of its common
shares, the tax treatment of which is described below.
ElderTrust is required to withhold 10% of any distribution in excess of
its current and accumulated E&P, even if a lower treaty rate applies and the
non-U.S. shareholder is not liable for tax on receipt of that distribution.
Consequently, although ElderTrust currently intends that its transfer agent will
withhold at a rate of 30%, or a lower applicable treaty rate, on the entire
amount of any distribution, to the extent that this is not done, any portion of
a distribution not subject to withholding at a rate of 30%, or lower applicable
treaty rate, would be subject to withholding at a rate of 10%. However, a
non-U.S. shareholder may seek a refund of such amounts from the IRS if it
subsequently determines that such distribution was, in fact, in excess of
current or accumulated E&P of ElderTrust, and the amount withheld exceeded the
non-U.S. shareholder's United States tax liability, if any, with respect to the
distribution.
Capital Gain Distributions; Retained Net Capital Gains
Distributions to a non-U.S. shareholder that are designated by
ElderTrust at the time of distribution as capital gain dividends, other than
those arising from the disposition of a United States real property interest,
generally should not be subject to United States federal income taxation,
unless:
(i) the investment in the common shares is effectively connected with
the non-U.S. shareholder's United States trade or business, in which
case the non-U.S. shareholder will be subject to the same treatment as
U.S. shareholders with respect to such gain, except that a shareholder
that is a foreign corporation may also be subject to the 30% branch
profits tax, as discussed above, or
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(ii) the non-U.S. shareholder is a nonresident alien individual who is
present in the United States for 183 days or more during the taxable
year and has a "tax home" in the United States, in which case the
nonresident alien individual will be subject to a 30% tax on the
individual's capital gains.
ElderTrust will be required to withhold and to remit to the IRS 35% of
any distribution to non-U.S. shareholders that is designated as a capital gain
dividend or, if greater, 35% of a distribution to non-U.S. shareholders that
could have been designated by ElderTrust as a capital gain dividend. The amount
withheld is creditable against the non-U.S. shareholder's United States federal
income tax liability.
Pursuant to the Foreign Investment in Real Property Tax Act, which is
referred to as "FIRPTA," distributions to a non-U.S. shareholder that are
attributable to gain from sales or exchanges by ElderTrust of United States real
property interests, whether or not designated as capital gain dividends, will
cause the non-U.S. shareholder to be treated as recognizing such gain as income
effectively connected with a United States trade or business. Non-U.S.
shareholders would thus generally be taxed at the same rates applicable to U.S.
shareholders, subject to a special alternative minimum tax in the case of
nonresident alien individuals. Also, such gain may be subject to a 30% branch
profits tax in the hands of a non-U.S. shareholder that is a corporation, as
discussed above. ElderTrust is required to withhold 35% of any such
distribution. That amount is creditable against the non-U.S. shareholder's
federal income tax liability.
Although the law is not clear on the matter, it appears that amounts
designated by ElderTrust as retained capital gains in respect of the common
shares held by U.S. shareholders (see "--Annual Distribution Requirements
Applicable to REITs" above) generally should be treated with respect to non-U.S.
shareholders in the same manner as actual distributions by ElderTrust of capital
gain dividends. Under that approach, the non-U.S. shareholders would be able to
offset as a credit against their United States federal income tax liability
resulting therefrom their proportionate share of the tax paid by ElderTrust on
such undistributed capital gains and to receive from the IRS a refund to the
extent their proportionate share of such tax paid by ElderTrust were to exceed
their actual United States federal income tax liability.
Dispositions of Common Shares
Gain recognized by a non-U.S. shareholder upon the sale or exchange of
common shares generally will not be subject to United States taxation unless
such shares constitute a "United States real property interest" within the
meaning of FIRPTA. The common shares will not constitute a "United States real
property interest" so long as ElderTrust is a "domestically controlled REIT." A
"domestically controlled REIT" is a REIT in which at all times during a
specified testing period less than 50% in value of its stock is held directly or
indirectly by non-U.S. shareholders. ElderTrust believes, but cannot guarantee,
that it is a "domestically controlled REIT." Moreover, even if ElderTrust is a
"domestically controlled REIT," because the common stock is publicly traded, no
assurance can be given that ElderTrust will continue to be a "domestically
controlled REIT." Notwithstanding the foregoing, gain from the sale or exchange
of common stock not otherwise subject to FIRPTA will be taxable to a non-U.S.
shareholder if either (a) the investment in ElderTrust common stock is
effectively connected with the non-U.S. shareholder's U.S. trade or business, in
which case the non-U.S. shareholder will be subject to the same treatment as
domestic shareholders with respect to any gain or (b) the non-U.S. shareholder
is a nonresident alien individual who is present in the United States for 183
days or more during the taxable year and has a "tax home" in the United States,
in which case the nonresident alien individual will be subject to a 30% United
States withholding tax on the amount of such individual's gain.
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Even if ElderTrust does not qualify as or ceases to be a "domestically
controlled REIT," gain arising from the sale or exchange by a non-U.S.
shareholder of common shares would not be subject to United States taxation
under FIRPTA as a sale of a "United States real property interest" if:
(i) the common shares are "regularly traded," as defined by applicable
regulations, on an established securities market such as the NYSE; and
(ii) such non-U.S. shareholder owned, actually or constructively, 5% or
less of the outstanding common shares throughout the five-year period
ending on the date of the sale or exchange.
If gain on the sale or exchange of common shares were subject to
taxation under FIRPTA, the non-U.S. shareholder would be subject to regular
United States income tax with respect to such gain in the same manner as a
taxable U.S. shareholder (subject to any applicable alternative minimum tax and
a special alternative minimum tax in the case of nonresident alien individuals)
and the purchaser of the common shares would be required to withhold and remit
to the IRS 10% of the purchase price.
Backup Withholding Tax and Information Reporting
Backup withholding tax generally is a withholding tax imposed at the
rate of 30% (currently scheduled to be reduced to 28% by 2006) on certain
payments to persons that fail to furnish certain information under the United
States information reporting requirements. Backup withholding and information
reporting will generally not apply to distributions paid to non-U.S.
shareholders outside the United States that are treated as dividends subject to
the 30% (or lower treaty rate) withholding tax discussed above, capital gain
dividends or distributions attributable to gain from the sale or exchange by
ElderTrust of United States real property interests. As a general matter, backup
withholding and information reporting will not apply to a payment of the
proceeds of a sale of common shares by or through a foreign office of a foreign
broker. Generally, information reporting (but not backup withholding) will
apply, however, to a payment of the proceeds of a sale of common shares by a
foreign office of a broker that:
(a) is a United States person;
(b) derives 50% or more of its gross income for certain periods from
the conduct of a trade or business in the United States;
(c) is a "controlled foreign corporation," which is, generally, a
foreign corporation controlled by United States shareholders; or
(d) is a foreign partnership, if at any time during its tax year, one
or more of its partners are United States persons (as defined in
Treasury regulations) who in the aggregate hold more than 50% of the
income or capital interest in the partnership or if, at any time during
its tax year, such foreign partnership is engaged in a United States
trade or business.
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If, however, the broker has documentary evidence in its records that
the holder is a non-U.S. shareholder and certain other conditions are met or the
shareholder otherwise establishes an exemption, information reporting will not
apply. Payment to or through a United States office of a broker of the proceeds
of a sale of common shares is subject to both backup withholding and information
reporting unless the shareholder certifies under penalty of perjury that the
shareholder is a non-U.S. shareholder, or otherwise establishes an exemption. A
non-U.S. shareholder may obtain a refund of any amounts withheld under the
backup withholding rules by filing the appropriate claim for refund with the
IRS.
The IRS has issued final regulations regarding the withholding and
information reporting rules discussed above. In general, these regulations do
not alter the substantive withholding and information reporting requirements but
unify certification procedures and forms and clarify and modify reliance
standards. These regulations generally are effective for payments made after
December 31, 2000, subject to certain transition rules. A non-U.S. shareholder
should consult its own advisor regarding the effect of these regulations.
Proposed Legislation
The Jobs and Growth Act of 2003, proposed in the Senate on February 27,
2003, would eliminate one level of the "double taxation" that is currently
imposed on corporate income for regular C corporations by excluding corporate
dividends from an individual's taxable income to the extent that corporate
income tax has been paid on the corporate earnings from which the dividends are
paid. A REIT's shareholders generally would not be affected by these proposals
in their current form. However, to the extent that a REIT's distributions to
shareholders are comprised of dividends that the REIT has received from a C
corporation, some benefits of the proposal would flow through to individual
shareholders. Specifically, as the proposal is currently drafted, REIT
distributions that include dividends paid by a C Corporation, such as a taxable
REIT subsidiary, out of taxed earnings of the C Corporation would be excluded
from an individual shareholder's taxable income. In addition, a REIT would not
be required to include previously taxed C corporation dividends in its income
and individual shareholders might be entitled to increase their basis in their
REIT shares by the amount of any previously taxed C corporation dividends not
distributed by the REIT. The Jobs and Growth Act of 2003, if enacted, also would
contain mechanical adjustments to the REIT distribution requirements to reflect
the concepts described above. There can be no assurance regarding whether this
proposal, or similar proposals, will be enacted or the form in which they might
be enacted.
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