Exhibit 99.1
MATERIAL FEDERAL INCOME TAX CONSEQUENCES
The following discussion describes the material U.S. federal income tax
consequences relating to the taxation of Brandywine Realty Trust as a REIT and
the ownership and disposition of our common shares. As used herein, the
"Company" refers to Brandywine Realty Trust, a Maryland real estate investment
trust, and the "Operating Partnership" refers to Brandywine Operating
Partnership, L.P., a Delaware limited partnership of which the Company is the
sole general partner.
If the Company offers one or more series of preferred shares or debt
securities, information about any income tax consequences to holders of those
preferred shares or debt securities will be included in the documents pursuant
to which they are offered to the extent required by law.
Because this is a summary that is intended to address only material
federal income tax consequences relating to the ownership and disposition of our
common shares that will apply to all holders, this summary may not contain all
the information that may be important to you. As you review this discussion, you
should keep in mind that:
- the tax consequences to you may vary depending on your particular
tax situation;
- special rules that are not discussed below may apply to you if, for
example, you are a tax-exempt organization, a broker-dealer, a
non-U.S. person, a trust, an estate, a regulated investment company,
a financial institution, an insurance company, or otherwise subject
to special tax treatment under the Internal Revenue Code (the
"Code");
- this summary does not address state, local or non-U.S. tax
considerations (See "Other Tax Consequences");
- this summary deals only with our common shareholders that hold
common shares as "capital assets" within the meaning of Section 1221
of the Code; and
- this discussion is not intended to be, and should not be construed
as, tax advice.
You are urged both to review the following discussion and to consult
with your own tax advisor to determine the effect of ownership and disposition
of our common shares on your individual tax situation, including any state,
local or non-U.S. tax consequences.
The information in this summary is based on the current Code, current,
temporary and proposed Treasury regulations, the legislative history of the
Code, current administrative interpretations and practices of the Internal
Revenue Service, including its practices and policies as endorsed in private
letter rulings, which are not binding on the Internal Revenue Service, and
existing court decisions. Future legislation, regulations, administrative
interpretations and court decisions could change current law or adversely affect
existing interpretations of current law. Any change could apply retroactively.
We have not obtained any rulings from the Internal Revenue Service concerning
the tax treatment of the matters discussed in this summary. Therefore, it is
possible that the Internal Revenue Service could challenge the statements in
this summary, which do not bind the Internal Revenue Service or the courts, and
that a court could agree with the Internal Revenue Service.
Taxation of the Company as a REIT
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We elected to be taxed as a REIT for the taxable year ended December
31, 1986, and have operated and expect to continue to operate in such a manner
so as to remain qualified as a REIT for Federal income tax purposes.
An entity that qualifies for taxation as a REIT and distributes to its
shareholders an amount at least equal to 90% of its REIT taxable income
(determined without regard to the deduction for dividends paid and by excluding
any net capital gain) plus 90% of its income from foreclosure property (less the
tax imposed on such income) is generally not subject to Federal corporate income
taxes on net income that it currently distributes to shareholders. This
treatment substantially eliminates the "double taxation" (at the corporate and
shareholder levels) that generally results from investment in a corporation.
However, we will be subject to Federal income tax as follows:
(i) We will be taxed at regular corporate rates on any
undistributed REIT taxable income, including undistributed net capital gains.
(ii) Under certain circumstances, we may be subject to the "alternative
minimum tax" on our items of tax preference, if any.
(iii) If we have net income from prohibited transactions (which are, in
general, certain sales or other dispositions of property, other than foreclosure
property, held primarily for sale to customers in the ordinary course of
business) such income will be subject to a 100% tax. See "- Sale of Partnership
Property."
(iv) If we should fail to satisfy the 75% gross income test or the 95%
gross income test (as discussed below), and nonetheless have maintained our
qualification as a REIT because certain other requirements have been met, we
will be subject to a 100% tax on the net income attributable to the greater of
the amount by which we fail the 75% or 95% test, multiplied by a fraction
intended to reflect the Company's profitability.
(v) If we should fail to distribute during each calendar year at least
the sum of (1) 85% of our REIT ordinary income for such year, (2) 95% of our
REIT capital gain net income for such year, and (3) any undistributed taxable
income from prior years, we would be subject to a 4% excise tax on the excess of
such required distribution over the amounts actually distributed.
(vi) If we have (1) net income from the sale or other disposition of
"foreclosure property" (which is, in general, property acquired by the Company
by foreclosure or otherwise or default on a loan secured by the property) which
is held primarily for sale to customers in the ordinary course of business or
(2) other nonqualifying income from foreclosure property, we will be subject to
tax on such income at the highest corporate rate.
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(vii) If we were to acquire any asset from a taxable "C" corporation in
a carry-over basis transaction, we could be liable for specified tax liability
inherited from that "C" corporation with respect to that corporation's "built-in
gain" in its assets. Built-in gain is the amount by which an asset's fair market
value exceeds its adjusted tax basis. We would not be subject to tax on the
built in gain, however, if we do not dispose of the acquired property within the
10-year period following acquisition of such property.
Qualification of the Company as a REIT
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The Code defines a REIT as a corporation, trust or association:
(1) that is managed by one or more trustees or directors;
(2) the beneficial ownership of which is evidenced by transferable
shares or by transferable certificates of beneficial interest;
(3) that would be taxable as a domestic corporation but for Sections
856 through 859 of the Code;
(4) that is neither a financial institution nor an insurance company
subject to certain provisions of the 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 shares of which is owned, directly or indirectly, by
five or fewer individuals (as defined in the Code to include specified
entities);
(7) that makes an election to be taxable as a REIT, 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;
(8) that uses a calendar year for federal income tax purposes and
complies with the recordkeeping requirements of the Code and the Treasury
Regulations; and
(9) that meets other applicable tests, described below, regarding the
nature of its income and assets and the amount of its distributions.
Conditions (1) through (4) must be satisfied during the entire taxable
year, and condition (5) must be satisfied during at least 335 days of a taxable
year of 12 months, or during a proportionate part of a taxable year of less than
12 months. We have previously issued Common Shares in sufficient proportions to
allow us to satisfy requirements (5) and (6) (the "100 Shareholder" and
"five-or-fewer" requirements). In addition, our Declaration of Trust provides
restrictions regarding the transfer of our shares that are intended to assist us
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in continuing to satisfy the requirements described in conditions (5) and (6)
above. See "Description of Shares of Beneficial Interest - restrictions on
transfer." However, these restrictions may not ensure that we will, in all
cases, be able to satisfy the requirements described in conditions (5) and (6)
above. In addition, we have not obtained a ruling from the Internal Revenue
Service as to whether the provisions of our Declaration of Trust concerning
restrictions on transfer and conversion of Common Shares to "Excess Shares" will
allow us to satisfy condition (5) and (6). If we fail to satisfy such share
ownership requirements, our status as a REIT will terminate.
To monitor compliance with condition (6) above, a REIT is required to
send annual letters to its shareholders requesting information regarding the
actual ownership of its shares. If we comply with the annual letters requirement
and do not know or, exercising reasonable diligence, would not have known of our
failure to meet condition (6) above, then we will be treated as having met
condition (6) above.
Qualified REIT Subsidiaries
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We currently have three wholly-owned subsidiaries which are "qualified
REIT subsidiaries" and we may have additional wholly-owned "qualified REIT
subsidiaries" in the future. The Code provides that a corporation that is a
"qualified REIT subsidiary" shall not be treated as a separate corporation, and
all assets, liabilities and items of income, deduction and credit of a
"qualified REIT subsidiary" shall be treated as assets, liabilities and items of
income, deduction and credit of the REIT. A "qualified REIT subsidiary" is a
corporation, other than a taxable REIT subsidiary (discussed below), all of the
capital stock of which is owned by the REIT and that has not elected to be a
"Taxable REIT Subsidiary." In applying the requirements described herein, all of
our "qualified REIT subsidiaries" will be ignored, and all assets, liabilities
and items of income, deduction and credit of such subsidiaries will be treated
as our assets, liabilities and items of income, deduction and credit. These
subsidiaries, therefore, will not be subject to federal corporate income
taxation, although they may be subject to state and local taxation.
Taxable REIT Subsidiaries
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We currently have five "taxable REIT subsidiaries", and may have
additional taxable REIT subsidiaries in the future. A REIT may hold any direct
or indirect interest in a corporation that qualifies as a "taxable REIT
subsidiary" as long as the value of the REIT's holdings of taxable REIT
subsidiary securities do not exceed 20% of the value of the REIT's total assets.
To qualify as a taxable REIT subsidiary, the subsidiary and the REIT must make a
joint election to treat the subsidiary as a taxable REIT subsidiary. A taxable
REIT subsidiary also includes any corporation (other than a REIT or a qualified
REIT subsidiary) in which a taxable REIT subsidiary directly or indirectly owns
more than 35% of the total voting power or value. See "Asset Tests" below. A
taxable REIT subsidiary will pay tax at regular corporate income rates on any
taxable income it earns.
A taxable REIT subsidiary can perform tenant services without causing
the REIT to receive impermissible tenant services income under the REIT income
tests. However, several provisions regarding the arrangements between a REIT and
its taxable REIT subsidiaries ensure that a taxable REIT subsidiary will be
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subject to an appropriate level of federal income taxation. For example, a
taxable REIT subsidiary is limited in its ability to deduct interest payments
made to a REIT. In addition, a REIT will be obligated to pay a 100% penalty tax
on some payments that it receives or on certain expenses deducted by the taxable
REIT subsidiary if the economic arrangements between the REIT, the REIT's
tenants and the taxable REIT subsidiary are not comparable to similar
arrangements among unrelated parties.
Ownership of Partnership Interests by a REIT
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A REIT that is a partner in a partnership is deemed to own its
proportionate share of the assets of the partnership and is deemed to receive
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. Accordingly, our proportionate share of the
assets, liabilities and items of income of the Operating Partnership are treated
as assets, liabilities and items of income of ours for purposes of applying the
requirements described herein. The Company has control over the Operating
Partnership and substantially all of the partnership and limited liability
company subsidiaries of the Operating Partnership and intends to operate them in
a manner that is consistent with the requirements for qualification of the
Company as a REIT.
Income Tests
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In order to qualify as a REIT, we must generally satisfy two gross
income requirements on an annual basis. First, at least 75% of our 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" and, in certain
circumstances, interest) or from certain types of temporary investments. Second,
at least 95% of our gross income (excluding gross income from prohibited
transactions) for each taxable year must be derived from the same items which
qualify under the 75% gross income test, and from dividends, interest and gain
from the sale or disposition of securities.
Rents received by a REIT will qualify as "rents from real property" in
satisfying the gross income requirements described above only if several
conditions are met. First, the amount of rent must not be based in whole or in
part on the income or profits of any person. However, 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 gross
receipts or sales. Second, subject to certain limited exceptions, rents received
from a tenant will not qualify as "rents from real property" in satisfying the
gross income tests if the REIT, or a direct or indirect owner of 10% or more of
the REIT, directly or constructively, owns 10% or more of such tenant (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." Finally,
in order for rents received with respect to a property to qualify as "rents from
real property," the REIT generally must not operate or manage the property or
furnish or render services to tenants, except through an "independent
contractor" who is adequately compensated and from whom the REIT derives no
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income, or through a taxable REIT subsidiary. The "independent contractor"
requirement, however, does not apply to the extent the services provided by the
REIT are "usually or customarily rendered" in connection with the rental of
space for occupancy only, and are not otherwise considered "rendered to the
occupant." In addition, a de minimis rule applies with respect to non-customary
services. Specifically, if the value of the non-customary service income with
respect to a property (valued at no less than 150% of the direct costs of
performing such services) is 1% or less of the total income derived from the
property, then all rental income except the non-customary service income will
qualify as "rents from real property." A taxable REIT subsidiary may provide
services (including noncustomary services) to a REIT's tenants without
"tainting" any of the rental income received by the REIT, and will be able to
manage or operate properties for third parties and generally engage in other
activities unrelated to real estate.
We do not anticipate receiving rent 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 or percentages of gross receipts or sales consistent with the
rules described above). We also do not anticipate receiving more than a de
minimis amount of rents from any related party tenant or rents attributable to
personal property leased in connection with real property that will exceed 15%
of the total rents received with respect to such real property.
We provide certain services with respect to our properties through the
Operating Partnership, which is not an "independent contractor." However, we
believe that all of such services will be considered "usually or customarily
rendered" in connection with the rental of space for occupancy only so that the
provision of such services will not jeopardize the qualification of rent from
the properties as "rents from real property." In the case of any services that
are not "usual and customary" under the foregoing rules, we will employ an
"independent contractor" or a taxable REIT subsidiary to provide such services.
The Operating Partnership may receive certain types of income that will
not qualify under the 75% or 95% gross income tests. In particular, dividends
received from a taxable REIT subsidiary will not qualify under the 75% test. We
believe, however, that the aggregate amount of such items and other
non-qualifying income in any taxable year will not cause us to exceed the limits
on non-qualifying income under either the 75% or 95% gross income tests.
If we fail to satisfy one or both of the 75% of 95% gross income tests
for any taxable year, we may nevertheless qualify as a REIT for such year if we
are entitled to relief under certain provisions of the Code. These relief
provisions will be generally available if (i) the failure to meet such tests was
due to reasonable cause and not due to willful neglect, (ii) we have attached a
schedule of the sources of our income to our return, and (iii) any incorrect
information on the schedule was not due to fraud with intent to evade tax. It is
not possible, however, to state whether in all circumstances we would be
entitled to the benefit of these relief provisions. As discussed above in
"Taxation of the Company as a REIT," even if these relief provisions apply, a
tax would be imposed based on the excess net income.
Any gain realized by us 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 our share of this type of gain realized by the Operating
Partnership, will be treated as income from a prohibited transaction that is
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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 on all the facts and
circumstances of a particular transaction. We intend to hold properties for
investment with a view to long-term appreciation, to engage in the business of
acquiring, developing, owning and operating properties, and to make occasional
sales of properties as are consistent with our investment objectives. We cannot
provide any assurance, however, that the Internal Revenue Service might not
contend that one or more of these sales are subject to the 100% penalty tax.
Asset Tests
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At the close of each quarter of each taxable year, we must satisfy the
following tests relating to the nature of our assets:
First, at least 75% of the value of our total assets must be
represented by cash or cash items (which generally include receivables),
government securities, "real estate assets" (which generally include interests
in real property, interests in mortgages on real property and shares of other
REITs), or, in cases where we receive proceeds from shares of beneficial
interest or publicly offered long- term (at least five-year) debt, temporary
investments in stock or debt instruments during the one-year period following
our receipt of such proceeds.
Second, of the investments not included in the 75% asset class, the
value of any one issuer's securities we own may not exceed 5% of the value of
our total assets; and we may not own more than 10% of the vote or value of any
one issuer's outstanding securities, except for our interests in the Operating
Partnership, noncorporate subsidiaries, taxable REIT subsidiaries and any
qualified REIT subsidiaries, and except (with respect to the 10% value test)
certain "straight debt" securities.
Third, not more than 20% of the value of our assets may be represented
by securities of one or more taxable REIT subsidiaries.
For purposes of the 75% asset test, the term "interest in real
property" includes an interest in land and improvements thereon, such as
buildings or other inherently permanent structures, including items that are
structural components of such buildings or structures, a leasehold of real
property, and an option to acquire real property, or a leasehold of real
property.
For purposes of the asset tests, we are deemed to own our proportionate
share of the assets of the Operating Partnership, any qualified REIT subsidiary,
and each noncorporate subsidiary, rather than our interests in those entities.
At least 75% of the value of our total assets have been and will be represented
by real estate assets, cash and cash items, including receivables and government
securities. In addition, except for our interests in the Operating Partnership,
the noncorporate subsidiaries, another REIT, any taxable REIT subsidiary and any
qualified REIT subsidiary, we have not owned, and will not own (i) securities of
any one issuer the value of which exceeds 5% of the value of our total assets,
or (ii) more than 10% of the vote or value of any one issuer's outstanding
securities. We have not owned, and will not own, securities of taxable REIT
subsidiaries with an aggregate value in excess of 20% of the value of our
assets.
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As noted above, one of the requirements for qualification as a REIT is
that a REIT not own more than 10% of the vote or value of any corporation other
than the stock of a qualified REIT subsidiary (of which the REIT is required to
own all of such stock), a taxable REIT subsidiary and stock in another REIT. The
Operating Partnership owns 95% of the vote and value of Brandywine Realty
Service Corporation, which is a taxable REIT subsidiary. In addition, the
Operating Partnership owns 100% of the vote and value of BTRS, Inc., Valleybrook
Land Holdings, Inc. and Southpoint Land Holdings, Inc., and 100% of the
membership interests of e-Tenants.com LLC (an entity that elected to be taxed as
a corporation) each of which is taxable REIT subsidiary. We and each taxable
REIT subsidiary have jointly made a taxable REIT subsidiary election and,
therefore, ownership of such subsidiaries will not violate the 10% test.
We own 100% of the common shares of Atlantic American Properties Trust,
a Maryland business trust that has elected to be treated as a real estate
investment trust ("AAPT"). Provided that AAPT continues to qualify as a REIT
(including satisfaction of the ownership, income, asset and distribution tests
discussed herein) the common shares of AAPT will qualify as real estate assets
under the 75% test. However, if AAPT fails to qualify as a REIT in any year,
then the common shares of AAPT will not qualify as real estate assets under the
75% test. In addition, because we own more than 10% of the common shares of
AAPT, the Company would not satisfy the 10% test if AAPT were to fail to qualify
as a REIT. Accordingly, the Company's qualification as a REIT depends upon the
ability of AAPT to continue to qualify as a REIT.
After initially meeting the asset tests at the close of any quarter, we
will not lose our 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 disposition of
sufficient nonqualifying assets within 30 days after the close of that quarter.
We intend to maintain adequate records of the value of our assets to ensure
compliance with the asset tests, and to take such other action within 30 days
after the close of any quarter as may be required to cure any noncompliance.
However, there can be no assurance that such other action will always be
successful. If we fail to cure any noncompliance with the asset tests within
such time period, our status as a REIT would be lost.
Annual Distribution Requirements
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In order to qualify as a REIT, we are required to distribute dividends
(other than capital gain dividends) to our shareholders in an amount at least
equal to (A) the sum of (i) 90% of the Company's "REIT taxable income" (computed
without regard to the dividends paid deduction and the REIT's net capital gain)
and (ii) 90% of the net income (after tax), if any, from foreclosure property,
minus (B) certain "excess" non-cash income. In addition, if we dispose of a
built-in gain asset during the 10 year period following its acquisition, we will
be required to distribute at least 90% of the built-in gain (after tax), if any,
recognized on the disposition of such asset. Such distributions must be paid in
the taxable year to which they relate, or in the following taxable year if
declared before the Company timely files its tax return for such year and if
paid on or before the first regular dividend payment after such declaration. To
the extent that we do not distribute all of our net capital gain or we
distribute at least 95%, but less than 100%, of our "REIT taxable income," as
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adjusted, we will be subject to tax on the undistributed amount at regular
corporate tax rates. Furthermore, if we should fail to distribute during each
calendar year at least the sum of (i) 85% of our REIT ordinary income for such
year, (ii) 95% of our REIT net capital gain income for such year and (iii) any
undistributed taxable income from prior periods, we would be subject to a 4%
excise tax on the excess of such required distribution over the amounts actually
distributed.
We intend to make timely distributions sufficient to satisfy the annual
distribution requirements. In this regard, the limited partnership agreement of
the Operating Partnership authorizes us, as general partner, to operate the
partnership in a manner that will enable us to satisfy the REIT requirements and
avoid the imposition of any federal income or excise tax liability. It is
possible that we, from time to time, may not have sufficient cash or other
liquid assets to meet the 90% distribution requirement due primarily to the
expenditure of cash for nondeductible items such as principal amortization or
capital expenditures. In order to meet the 90% distribution requirement, we may
borrow or may cause the Operating Partnership to arrange for short-term or other
borrowing to permit the payment of required distributions or declare a consent
dividend, which is a hypothetical distribution to shareholders out of the
earnings and profits of the Company. The effect of such a consent dividend
(which, in conjunction with distributions actually paid, must not be
preferential to those shareholders who agree to such treatment) would be that
such shareholders would be treated for federal income tax purposes as if they
had received such amount in cash, and they then had immediately contributed such
amount back to the Company as additional paid-in capital. This would result in
taxable income to those shareholders without the receipt of any actual cash
distribution but would also increase their tax basis in their shares by the
amount of the taxable income recognized.
Under certain circumstances, we may be able to rectify a failure to
meet the distribution requirement for a given year by paying "deficiency
dividends" to shareholders in a later year that may be included in the Company's
deduction for distributions paid for the earlier year. Thus, we may be able to
avoid being taxed on amounts distributed as deficiency dividends; however, we
will be required to pay to the Internal Revenue Service interest based upon the
amount of any deduction taken for deficiency dividends.
Failure to Qualify
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If we fail to qualify for taxation as a REIT in any taxable year and
the relief provisions do not apply we will be subject to tax (including any
applicable corporate alternative minimum tax) on our taxable income at regular
corporate rates. Distributions to shareholders in any year in which we fail to
qualify will not be deductible to us. In such event, to the extent of our
current and accumulated earnings and profits, all distributions to shareholders
will be taxable to them as ordinary income, and, subject to certain limitations
of the Code, corporate distributees may be eligible for the dividends received
deduction. Unless entitled to relief under specific statutory provisions, we
also will 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 we would be entitled to such statutory
relief.
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Income Taxation of the Operating Partnership, Subsidiary Partnerships
and Their Partners
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The following discussion summarizes certain Federal income tax
considerations applicable to the Company's investment in the Operating
Partnership and the Operating Partnership's subsidiary partnerships and limited
liability companies (referred to as the "Subsidiary Partnerships").
Classification of the Operating Partnership and Subsidiary Partnerships
as Partnerships
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We own all of our Properties or the economic interests therein through
the Operating Partnership. We will be entitled to include in our income our
distributive share of the income and to deduct our distributive share of the
losses of the Operating Partnership (including the Operating Partnership's share
of the income or losses of the Subsidiary Partnerships) only if the Operating
Partnership and the Subsidiary Partnerships (collectively, the "Partnerships")
are classified for Federal income tax purposes as partnerships rather than as
associations taxable as corporations. For taxable periods prior to January 1,
1997, an organization formed as a partnership was treated as a partnership for
Federal income tax purposes rather than as a corporation only if it had no more
than two of the four corporate characteristics that the Treasury Regulations
used to distinguish a partnership from a corporation for tax purposes. These
four characteristics were continuity of life, centralization of management,
limited liability and free transferability of interests.
Neither the Operating Partnership nor any of the Subsidiary
Partnerships requested a ruling from the Internal Revenue Service that it would
be treated as a partnership for Federal income tax purposes.
Effective January 1, 1997, Treasury Regulations eliminated the
four-factor test described above and, instead, permit partnerships and other
non-corporate entities to be taxed as partnerships for federal income tax
purposes without regard to the number of corporate characteristics possessed by
such entity. Under those Treasury Regulations, both the Operating Partnership
and each of the Subsidiary Partnerships will be classified as partnerships for
federal income tax purposes unless an affirmative election is made by the entity
to be taxed as a corporation. We have represented that no such election has been
made, or is anticipated to be made, on behalf of the Operating Partnership or
any of the Subsidiary Partnerships (except with respect to e-Tenants.com LLC).
Under a special transitional rule in the Treasury Regulations, the Internal
Revenue Service will not challenge the classification of an existing entity such
as the Operating Partnership or a Subsidiary Partnership for periods prior to
January 1, 1997 if: (i) the entity has a "reasonable basis" for its
classification; (ii) the entity and each of its members recognized the federal
income tax consequences of any change in classification of the entity made
within the 60 months prior to January 1, 1997; and (iii) neither the entity nor
any of its members had been notified in writing on or before May 8, 1996 that
its classification was under examination by the Internal Revenue Service.
Neither the Operating Partnership nor any of the Subsidiary Partnerships changed
its classification within the 60 month period preceding May 8, 1996, nor was any
one of them notified that its classification as a partnership for federal income
tax purposes was under examination by the Internal Revenue Service.
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If for any reason the Operating Partnership or a Subsidiary Partnership
were classified as an association taxable as a corporation rather than as a
partnership for Federal income tax purposes, we would not be able to satisfy the
income and asset requirements for REIT status. See "-- Income Tests" and "--
Asset Tests." In addition, any change in any such Partnership's status for tax
purposes might be treated as a taxable event, in which case we might incur a tax
liability without any related cash distribution. See "-- Annual Distribution
Requirements." Further, items of income and deduction of any such Partnership
would not pass through to its partner (e.g., the Company), and its partners
would be treated as shareholders for tax purposes. Any such Partnership would be
required to pay income tax at corporate tax rates on its net income and
distributions to its partners would constitute dividends that would not be
deductible in computing such Partnership's taxable income.
Partnership Allocations
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Although a partnership agreement will generally determine the
allocation of income and losses among partners, such allocations will be
disregarded for tax purposes if they do not comply with the provisions of
Section 704(b) of the Code and the Treasury Regulations promulgated thereunder,
which 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 Operating Partnership's
allocations of taxable income and loss are intended to comply with the
requirements of Section 704(b) of the Code and the Treasury Regulations
promulgated thereunder.
Tax Allocations With Respect to Contributed Properties
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We believe that the fair market values of the properties contributed
directly or indirectly to the Operating Partnership in various transactions were
different than the tax basis of such Properties. Pursuant to Section 704(c) of
the Code, items of 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 for Federal income tax purposes in
a manner such that the contributor is charged with or benefits from the
unrealized gain or unrealized loss associated with the property at the time of
the contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (the "Pre-Contribution Gain or Loss").
The partnership agreement of the Operating Partnership requires allocations of
income, gain, loss and deduction attributable to such contributed property to be
made in a manner that is consistent with Section 704(c) of the Code. Thus, if
the Operating Partnership sells contributed property at a gain or loss, such
gain or loss will be allocated to the contributing partners, and away from us,
generally to the extent of the Pre-Contribution Gain or Loss.
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The Treasury Department has issued final regulations under Section
704(c) of the Code which give partnerships flexibility in ensuring that a
partner contributing property to a partnership receives the tax benefits and
burdens of any Pre-Contribution Gain or Loss attributable to the contributed
property. These regulations permit partnerships to use any "reasonable method"
of accounting for Pre-Contribution Gain or Loss. These regulations specifically
describe three reasonable methods, including (i) the "traditional method" under
current law, (ii) the traditional method with the use of "curative allocations"
which would permit distortions caused by Pre-Contribution Gain or Loss to be
rectified on an annual basis and (iii) the "remedial allocation method" which is
similar to the traditional method with "curative allocations." The partnership
agreement of the Operating Partnership permits us, as general partner, to select
one of these methods to account for Pre-Contribution Gain or Loss.
Depreciation
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The Operating Partnership's assets other than cash consist largely of
appreciated property contributed by its partners. Assets contributed to a
partnership in a tax-free transaction generally retain the same depreciation
method and recovery period as they had in the hands of the partner who
contributed them to the partnership. Accordingly, the Operating Partnership's
depreciation deductions for its real property are based largely on the historic
tax depreciation schedules for the properties prior to their contribution to the
Operating Partnership. The properties are being depreciated over a range of 15
to 40 years using various methods of depreciation which were determined at the
time that each item of depreciable property was placed in service. Any
depreciable real property purchased by the Partnerships is currently depreciated
over 40 years. In certain instances where a partnership interest rather than
real property is contributed to the Partnership, the real property may not carry
over its recovery period but rather may, similarly, be subject to the lengthier
recovery period.
Section 704(c) of the Code requires that depreciation as well as gain
and loss be allocated in a manner so as to take into account the variation
between the fair market value and tax basis of the property contributed. Thus,
because most of the property contributed to the Operating Partnerships is
appreciated, we will generally receive allocations of tax depreciation in excess
of our percentage interest in the Operating Partnership. Depreciation with
respect to any property purchased by the Operating Partnership subsequent to the
admission of its partners, however, will be allocated among the partners in
accordance with their respective percentage interests in the Operating
Partnership.
As described previously, we, as a general partner of the Operating
Partnership, may select any permissible method to account for Pre-Contribution
Gain or Loss. The use of certain of these methods may result in us being
allocated lower depreciation deductions than if a different method were used.
The resulting higher taxable income and earnings and profits, as determined for
federal income tax purposes, should decrease the portion of distributions which
may be treated as a return of capital. See "- Taxation Taxable Domestic
Shareholders."
Basis in Operating Partnership Interest
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Our adjusted tax basis in each of the partnerships in which we have an
interest generally (i) will be equal to the amount of cash and the basis of any
other property contributed to such partnership by us, (ii) will be increased by
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(a) our allocable share of such partnership's income and (b) our allocable share
of any indebtedness of such partnership, and (iii) will be reduced, but not
below zero, by our allocable share of (a) such partnership's loss and (b) the
amount of cash and the tax basis of any property distributed to us and by
constructive distributions resulting from a reduction in our share of
indebtedness of such partnership.
If our allocable share of the loss (or portion thereof) of any
partnership in which we have an interest would reduce the adjusted tax basis of
our partnership interest in such partnership below zero, the recognition of such
loss will be deferred until such time as the recognition of such loss (or
portion thereof) would not reduce our adjusted tax basis below zero. To the
extent that distributions to us from a partnership, or any decrease in our share
of the nonrecourse indebtedness of a partnership (each such decrease being
considered a constructive cash distribution to the partners), would reduce our
adjusted tax basis below zero, such distributions (including such constructive
distributions) would constitute taxable income to us. Such distributions and
constructive distributions normally would be characterized as long-term capital
gain if our interest in such partnership has been held for longer than the
long-term capital gain holding period (currently 12 months).
Sale of Partnership Property
- ----------------------------
Generally, any gain realized by a partnership on the sale of property
held by the partnership for more than 12 months will be long-term capital gain,
except for any portion of such gain that is treated as depreciation or cost
recovery recapture. However, under requirements applicable to REITS under the
Code, our share as a partner of any gain realized by the Operating Partnership
on the sale of any property held as inventory or other property held primarily
for sale to customers in the ordinary course of a trade or business will be
treated as income from a prohibited transaction that is subject to a 100%
penalty tax. See "- Taxation of the Company as a REIT." Such prohibited
transaction income will also have an adverse effect upon our ability to satisfy
the income tests for REIT status. See "-- Income Tests." 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 on all the facts and
circumstances with respect to the particular transaction. A safe harbor to avoid
classification as a prohibited transaction exists as to real estate assets held
for the production of rental income by a REIT if the following requirements are
satisfied: (i) the REIT has held the property for at least four years, (ii)
aggregate expenditures of the REIT during the four-year period preceding the
sale which are includible in basis do not exceed 30% of the net selling price of
the property, (iii) (I) during the taxable year the REIT has made no more than
seven sales of property or, in the alternative, (II) the aggregate of the
adjusted bases of all properties sold during the year does not exceed 10% of the
adjusted bases of all of the REIT's properties during the year, (iv) in the case
of property, not acquired through foreclosure or lease termination, the REIT has
held the property for not less than four years for the production of rental
income, and (v) if the requirement of clause (iii) (I) is not satisfied,
substantially all of the marketing and development expenditures were made
through an independent contractor. We, as general partner of the Operating
Partnership, believe that the Partnerships intend to hold their properties for
investment with a view to long-term appreciation, to engage in the business of
acquiring, developing, owning, operating and leasing properties and to make such
occasional sales of the properties as are consistent with our and the Operating
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Partnership's investment objectives. No assurance can be given, however, that
every property sale by the Partnerships will constitute a sale of property held
for investment.
Taxation of Taxable Domestic Shareholders
- -----------------------------------------
As long we qualify as a REIT, distributions made to our taxable U.S.
shareholders out of current or accumulated earnings and profits (and not
designated as capital gain dividends or qualified dividend income) will be
dividends taxable to such U.S. shareholders as ordinary income and will not be
eligible for the dividends received deduction for corporations. Distributions
that are designated as long-term capital gain dividends will be taxed as
long-term capital gains (to the extent they do not exceed our actual net capital
gain for the taxable year) without regard to the period for which the
shareholder has held its shares of beneficial interest. However, corporate
shareholders may be required to treat up to 20% of certain capital gain
dividends as ordinary income. For calendar years 2003 through 2008,
distributions that are designated as qualified dividend income will be taxed at
the same rate as long-term capital gains. We may designate a distribution as
qualified dividend income to the extent of (i) qualified dividend income we
receive during the current year (for example, dividends received from a taxable
REIT subsidiary), and (ii) income on which we have been subject to corporate
level tax during the prior year (for example, undistributed REIT taxable income)
less the tax paid on that income. Distributions in excess of current and
accumulated earnings and profits will not be taxable to a shareholder to the
extent that they do not exceed the adjusted basis of the shareholder's shares,
but rather will reduce the adjusted basis of such shares. To the extent that
distributions in excess of current and accumulated earnings and profits exceed
the adjusted basis of a shareholder's shares, such distributions will be
included in income as long-term capital gain (or short-term capital gain if the
shares have been held for 12 months or less) assuming the shares are a capital
asset in the hands of the shareholder. In addition, any distribution declared by
us in October, November or December of any year payable to a shareholder of
record on a specified date in any such month shall be treated as both paid by
the Company and received by the shareholder on December 31 of such year,
provided that the distribution is actually paid by the Company during January of
the following calendar year. Shareholders may not include in their individual
income tax returns any losses of the Company.
In general, any loss upon a sale or exchange of shares by a shareholder
who has held such shares for six months or less (after applying certain holding
period rules) will be treated as a long-term capital loss to the extent such
shareholder has received distributions from us required to be treated as
long-term capital gain. Shareholders who realize a loss on the sale or exchange
of shares may be required to file IRS Form 8886, Reportable Transaction
Disclosure Statement, if the loss exceeds certain thresholds (for individual
taxpayers, the threshold is $2,000,000 for a loss in a single taxable year).
Shareholders should consult with their tax advisors regarding Form 8886 filing
requirements.
Distributions from us and gain from the disposition of shares will not
be treated as passive activity income and, therefore, shareholders will not be
able to apply any "passive losses" against such income. Dividends from us (to
the extent they do not constitute a return of capital or capital gain dividends)
and, on an elective basis, capital gain dividends and gain from the disposition
of shares will generally be treated as investment income for purposes of the
investment income limitation.
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Backup Withholding
- ------------------
We will report to our U.S. shareholders and the Internal Revenue
Service the amount of distributions paid during each calendar year, and the
amount of tax withheld, if any. Under the backup withholding rules, a
shareholder may be subject to backup withholding at the rate of 28% with respect
to distributions paid unless such shareholder (a) is a corporation or comes
within certain other exempt categories and, when required, demonstrates this
fact, or (b) 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 shareholder that does not
provide us with his correct taxpayer identification number may also be subject
to penalties imposed by the Internal Revenue Service. Any amount paid as backup
withholding may be credited against the shareholder's income tax liability. In
addition, we may be required to withhold a portion of capital gain distributions
to any shareholders who fail to certify their non-foreign status to the Company.
See "- Taxation of Foreign Shareholders."
Taxation of Tax-Exempt Shareholders
- -----------------------------------
Distributions by us to a shareholder that is a tax-exempt entity should
not constitute "unrelated business taxable income" ("UBTI"), as defined in
Section 512(a) of the Code provided that the tax-exempt entity has not financed
the acquisition of its shares with "acquisition indebtedness" within the meaning
of the Code and the shares are not otherwise used in an unrelated trade or
business of the tax-exempt entity.
In the case of a "qualified trust" (generally, a pension or
profit-sharing trust) holding shares in a REIT, the beneficiaries of the trust
are treated as holding shares in the REIT in proportion to their actuarial
interests in the qualified trust, instead of treating the qualified trust as a
single individual (the "look-through exception"). A qualified trust that holds
more than 10% of the shares of a REIT is required to treat a percentage of REIT
dividends as UBTI if the REIT incurs debt to acquire or improve real property.
This rule applies, however, only if (i) the qualification of the REIT depends
upon the application of the "look through" exception (described above) to the
restriction on REIT shareholdings by five or fewer individuals, including
qualified trusts (see "Description of Shares of Beneficial Interest -
Restrictions on Transfer") and (ii) the REIT is "predominantly held" by
qualified trusts, i.e., if either (x) a single qualified trust holds more than
25% by value of the interests in the REIT or (y) one or more qualified trusts,
each owning more than 10% by value, holds in the aggregate more than 50% of the
interests in the REIT. The percentage of any dividend paid (or treated as paid)
to such a qualified trust that is treated as UBTI is equal to the amount of
modified gross income (gross income less directly connected expenses) from the
unrelated trade or business of the REIT (treating the REIT as if it were a
qualified trust), divided by the total modified gross income of the REIT. A de
minimis exception applies where the percentage is less than 5%.
Taxation of Foreign Shareholders
- --------------------------------
The rules governing United States Federal income taxation of
nonresident alien individuals, foreign corporations, foreign partnerships and
other foreign shareholders (collectively, "Non-U.S. Shareholders") are complex
and no attempt will be made herein to provide more than a summary of such rules.
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Prospective Non-U.S. Shareholders should consult with their own tax advisors to
determine the impact of Federal, state and local income tax laws with regard to
an investment in our shares, including any reporting requirements.
Distributions made by us that are not attributable to gain from sales
or exchanges by us of United States real property interests and not designated
by us as capital gains dividends will be treated as dividends of ordinary income
to the extent that they are made out of current or accumulated earnings and
profits of the Company. Such distributions will ordinarily be subject to a
withholding tax equal to 30% of the gross amount of the distribution unless an
applicable tax treaty reduces or eliminates that tax. However, if income from
the investment in our shares is treated as effectively connected with the
Non-U.S. Shareholder's conduct of a United States trade or business, the
Non-U.S. Shareholder generally will be subject to a tax at graduated rates, in
the same manner as U.S. shareholders are taxed with respect to such
distributions (and may also be subject to the 30% branch profits tax in the case
of a shareholder that is a foreign corporation). We expect to withhold United
States income tax at the rate of 30% on the gross amount of any such
distributions made to a Non-U.S. Shareholder unless (i) a lower treaty rate
applies or (ii) the Non-U.S. Shareholder files an IRS Form W-8ECI with us
claiming that the distribution is effectively connected income. Distributions in
excess of our current and accumulated earnings and profits will not be taxable
to a shareholder to the extent that such distributions do not exceed the
adjusted basis of the shareholder's shares, but rather will reduce the adjusted
basis of the shareholder in such shares. To the extent that distributions in
excess of current and accumulated earnings and profits exceed the adjusted basis
of a Non-Shareholder's shares, such distributions will give rise to tax
liability if the Non-U.S. Shareholder would otherwise be subject to tax on any
gain from the sale or disposition of its shares, as described below. If it
cannot be determined at the time a distribution is made whether or not such
distribution will be in excess of current and accumulated earnings and profits,
the distributions will be subject to withholding at the same rate as dividends.
However, amounts thus withheld are refundable to the shareholder if it is
subsequently determined that such distribution was, in fact, in excess of our
current and accumulated earnings and profits.
For any year in which we qualify as a REIT, distributions that are
attributable to gain from sales or exchanges by us of United States real
property interests will be taxed to a Non-U.S. Shareholder under the provisions
of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Under
FIRPTA, distributions attributable to gain from sales of United States real
property interests are taxed to a Non-U.S. Shareholder as if such gain were
effectively connected with a United States business. Individuals who are
Non-U.S. Shareholders would thus be taxed at the normal capital gain rates
applicable to U.S. individual shareholders (subject to applicable alternative
minimum tax and a special alternative minimum tax in the case of nonresident
alien individuals). Also, distributions subject to FIRPTA may be subject to a
30% branch profits tax in the hands of a foreign corporate shareholder not
entitled to treaty relief. We are required by applicable Treasury Regulations to
withhold 35% of any distribution that could be designated by us as a capital
gains dividend. The amount is creditable against the Non-U.S. Shareholder's U.S.
tax liability.
Gain recognized by a Non-U.S. Shareholder upon a sale of shares
generally will not be taxed under FIRPTA if the Company is a "domestically
controlled REIT," defined generally as a REIT in which at all times during a
specified testing period less than 50% in value of the shares of beneficial
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interest was held directly or indirectly by foreign persons. It is currently
anticipated that we will be a "domestically controlled REIT," and therefore the
sale of shares by a Non-U.S. Shareholder will not be subject to taxation under
FIRPTA. However, because the shares may be traded, we cannot be sure that we
will continue to be a "domestically controlled REIT." Gain not subject to FIRPTA
will be taxable to a Non-U.S. Shareholder if (i) investment in the 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 or (ii) the Non-U.S.
Shareholder is a nonresident alien individual who was present in the United
States for 183 days or more during the taxable year, in which case the
nonresident alien individual will be subject to a 30% tax on the individual's
capital gains. If the gain on the sale of shares were to be subject to taxation
under FIRPTA, the Non-U.S. Shareholder would be subject to the same treatment as
U.S. shareholders with respect to such gain (subject to applicable alternative
minimum tax and a special alternative minimum tax in the case of nonresident
alien individuals).
Statement of Share Ownership
- ----------------------------
We are required to demand annual written statements from the record
holders of designated percentages of our shares disclosing the actual owners of
the shares. We must also maintain, within the Internal Revenue District in which
we are required to file our federal income tax return, permanent records showing
the information we have received as to the actual ownership of such shares and a
list of those persons failing or refusing to comply with such demand.
Other Tax Consequences
- ----------------------
We, the Operating Partnership, the Subsidiary Partnerships and our
shareholders may be subject to state or local taxation in various state or local
jurisdictions, including those in which it or they transact business or reside.
The state and local tax treatment of us, the Operating Partnership, the
Subsidiary Partnerships and our shareholders may not conform to the Federal
income tax consequences discussed above. A recent legislative change in
Pennsylvania, where we have significant holdings, may cause shareholders that
are corporations or LLCs to be subject to Pennsylvania Corporate Net Income Tax
and/or the Franchise Tax. Consequently, prospective shareholders should consult
their own tax advisors regarding the effect of state and local tax laws on an
investment in the Company.
Possible Federal Tax Developments
- ---------------------------------
The rules dealing with Federal income taxation are constantly under
review by the Internal Revenue Service, the Treasury Department and Congress.
New Federal tax legislation or other provisions may be enacted into law or new
interpretations, rulings, Treasury Regulations or court decisions could be
adopted, all of which could adversely affect the taxation of the Company or of
its shareholders. We cannot predict the likelihood of passage of any new tax
legislation or other provisions or court decisions either directly or indirectly
affecting us or our shareholders. Consequently, the tax treatment described
herein may be modified prospectively or retroactively by legislative, judicial
or administrative action.
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