Lease structuring for tax purposes: Optimizing leases through analysis

Regulations related to real estate investment trusts (REIT), unrelated business taxable income (UBTI) and other policies require that "arms-length" leases among ownership entities (a REIT or OwnCo) and their wholly-owned subsidiaries (a taxable REIT subsidiary or LeaseCo) be structured based on revenue from operations and not operating income. As your investment vehicle acquires lodging and other asset types with operational business components, PwC can assist you. Our hospitality and tax professionals' extensive industry and financial knowledge provide you with assistance in your lease structuring needs.

Lodging and other service-related real estate assets are management intensive and have unique fixed and variable components to their operating revenues and expenses. Knowledge of these expenses and revenues is critical in properly calculating the potential effects on taxable income of changes in such metrics as occupancy or average daily rate.

The risks associated with structuring leases include:

  • Not allowing enough taxable income at the subsidiary, which could lead to questions regarding the "arms-length" nature of the lease
  • Allowing excessive taxable income at the subsidiary (TRS or LeaseCo), which could increase the effective tax rate of an investment vehicle

If this is your situation

  • You are involved in a lodging or service-related asset transaction and your primary business objective is real estate ownership, not the operation and management of these assets.
  • You need a thorough analysis of how the fixed and variable natures of certain revenues and expenses can affect the potential upside and downside performances of your asset.
  • You need help with the iterative process of calculating potential lease terms to achieve your tax objectives.

How PwC can help you

Because our team of experienced professionals understands current practices, we help clients efficiently reduce risks associated with structuring leases under REIT and UBTI regulations. Understanding that each asset is different, PwC can assist you efficiently account for renovations, seasonality, brand changes and other property-level anomalies, allowing you to assess lease parameters that meet your expectations and minimize fluctuations in tenant income over the term of the lease. Additionally, our sensitivity analyses, which account for deviations in occupancy and average daily rate, help clients develop a level of confidence in their lease parameters.

Our analyses include:

  • Parameters used to establish the base and percentage rent assumptions of the lease
  • Property income statements adjusted for specific ownership nuances
  • Taxable income of the subsidiary
  • Sensitivity tables that illustrate taxable income as a percentage of revenue with changes in occupancy and average daily rate
Our professionals possess experience structuring leases for varied asset types, including:
  • Full-service hotels
  • Limited-service hotels
  • Extended-stay hotels
  • Senior-living facilities
  • Short-term housing facilities