12. INCOME TAXES:
The Company elected to be taxed as a REIT under the Code. A REIT will generally not be subject to federal income taxation on that portion of its income that qualifies as REIT taxable income, to the extent that it distributes at least 90% of its taxable income to its stockholders and complies with certain other requirements. It is management’s intention to adhere to these requirements and maintain the Company’s REIT status. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates (including any applicable minimum tax and may not be able to qualify as a REIT for four subsequent taxable years). Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and federal income and excise taxes on its undistributed taxable income. In addition, taxable income from non-REIT activities managed through taxable REIT subsidiaries are subject to federal, state, and local income taxes.
The recently enacted Tax Cuts and Jobs Act (the “Act”) is a complex revision to the U.S. federal income tax laws with impacts on different categories of taxpayers and industries, and will require subsequent rulemaking and interpretation in a number of areas. The long-term impact of the Act on the overall economy, government revenues, our tenants, our company, and the real estate industry cannot be reliably predicted at this time. Furthermore, the Act may impact certain of our tenants’ operating results, financial condition, and future business plans. There can be no assurance that the Act will not impact our operating results, financial condition, and future business operations.
Income from “qualified dividends” payable to U.S. stockholders that are individuals, trusts and estates are generally subject to tax at preferential rates. Dividends payable by REITs, however, generally are not eligible for the preferential tax rates applicable to qualified dividend income. Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, to the extent that the preferential rates continue to apply to regular corporate qualified dividends, investors who are individuals, trusts and estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could materially and adversely affect the value of the shares of REITs, including the value of our common stock.
The Act signed into law by the President on December 22, 2017 makes significant changes to the Code, including changes that impact REITs and their shareholders, among others. In particular, the Act reduces the maximum corporate tax rate from 35% to 21%. In addition, for tax years beginning before January 1, 2026, the Act permits up to a 20% deduction for individuals, trusts, and estates with respect to their receipt of “qualified REIT dividends”, which are dividends from a REIT that are not capital gain dividends and are not qualified dividend income. This provides closer parity between the treatment under the new law of ordinary REIT dividends and qualified dividends. These changes generally result in an effective maximum U.S. federal income tax rate on such dividends of 29.6%, if the deduction is allowed in full. However, by reducing the corporate tax rate, it is possible that the Act will nevertheless reduce the relative attractiveness to investors (as compared with potential alternative investments) of the generally single level of taxation on REIT distributions. Although certain changes to the Code are generally advantageous to REITs and their shareholders, the full ramifications of the Act remain unclear and will likely remain unclear for an indeterminate period of time. Key provisions of the Act that could impact us and the value of our shares include the following:
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temporarily reducing individual U.S. federal income tax rates on ordinary income; the highest individual U.S. federal income tax rate is reduced from 39.6% to 37% (through tax years beginning before January 1, 2026), while eliminating miscellaneous itemized deductions and limiting state and local tax deductions; |
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reducing the maximum corporate income tax rate from 35% to 21%, which reduces, but does not eliminate, the competitive advantage that REITs enjoy relative to non-REIT corporations; |
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permitting (subject to certain limitations) a deduction for certain pass-through business income, including, as noted above, dividends received by our stockholders that are not designated by us as capital gain dividends or qualified dividend income, which will allow individuals, trusts, and estates to deduct up to 20% of such amounts, generally resulting in an effective maximum U.S. federal income tax rate of 29.6% on such dividends, if the deduction is allowed in full (through tax years beginning before January 1, 2026); |
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reducing the highest rate of withholding with respect to our distributions to non-U.S. stockholders that are treated as attributable to gains from the sale or exchange of U.S. real property interests from 35% to 21%; |
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limiting our deduction for net operating losses to 80% of taxable income (prior to the application of the dividends paid deduction), where taxable income is determined without regarding to the net operating loss deduction itself, and generally eliminating net operating loss carrybacks and allowing unused net operating losses to be carried forward indefinitely; |
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amending the limitation on the deduction of net interest expense for all businesses, other than certain electing real estate businesses (which could adversely affect any of our taxable REIT subsidiaries (each, a “TRS”), including any new TRS that we may form); |
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expanding the ability of businesses to deduct the cost of certain purchases of property in the year in which such property is purchased; and |
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eliminating the corporate alternative minimum tax. |
The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury. Changes to the tax laws, with or without retroactive application, could adversely affect our stockholders or us. We cannot predict how changes in the tax laws might affect our stockholders or us. New legislation, Treasury Regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT or the federal income tax consequences of such qualification.
Reconciliation between GAAP Income From Continuing Operations and Federal Taxable Income:
The following table reconciles GAAP income from continuing operations to taxable income for the years ended December 31, 2017 and 2016 (in thousands):
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2017 |
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2016 |
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Net income from operations |
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$ |
3,596 |
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$ |
4,140 |
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GAAP net loss (income) of taxable subsidiaries |
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23 |
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(220 |
) |
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GAAP net income from REIT operations |
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3,619 |
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3,920 |
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Operating expense book deductions greater than tax |
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1,417 |
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324 |
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Book depreciation in excess of tax depreciation |
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5,204 |
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5,287 |
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GAAP amortization of intangibles in excess of tax amortization |
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1,981 |
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2,121 |
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Straightline rent adjustments |
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(468 |
) |
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(621 |
) |
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Acquisition costs capitalized for tax |
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398 |
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561 |
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(Income) allocable to noncontrolling interest |
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(5,682 |
) |
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(5,181 |
) |
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Estimated taxable income subject to the dividend requirement |
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$ |
6,469 |
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$ |
6,411 |
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We have determined for income tax purposes that the 2017 and 2016 regular dividends were considered ordinary dividends.
Taxable REIT Subsidiaries:
The Company is subject to federal, state, and local income taxes on the income from its Taxable REIT subsidiaries (“TRS”) activities, which include all the discontinued operations of Shelter Express, Inc. and subsidiaries. There were no provisions for (benefit from) income taxes from discontinued operations for the years ended December 31, 2017 and 2016. The TRS entities have approximately $20.0 million of net operating loss carry-forwards and $9.0 million of capital loss carryforwards at December 31, 2017. The Company has recorded a full valuation allowable against the deferred income tax assets as it does not consider realization of such assets to be likely than not. The Company has determined that any changes in the value of the deferred income tax assets would have no impact on the Company’s consolidated financial statements inasmuch as it would be offset by a full valuation allowance.