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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): MARCH 25, 1997
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JDN REALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
MARYLAND 1-12844 58-1468053
(State or Other (Commission File Number) (I.R.S. Employer
Jurisdiction of Identification
Incorporation) Number)
3340 PEACHTREE ROAD, N.E.
SUITE 1530
ATLANTA, GEORGIA 30326
(Address of Principal Executive Offices) (Zip Code)
(404) 262-3252
(Registrant's Telephone Number, including Area Code)
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ITEM 5. OTHER EVENTS AND INFORMATION.
Cautionary Statements for Purposes of the Private Securities
Litigation Reform Act of 1995. In connection with the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, JDN Realty
Corporation (the "Company") is hereby filing cautionary statements identifying
important factors that could cause the Company's actual results to differ
materially from those projected in forward-looking statements of the Company
made by, or on behalf of, the Company.
Federal Income Tax and ERISA Considerations. The Company is also
filing certain information regarding the Internal Revenue Code of 1986, as
amended (the "Code"), and the Employment Retirement Income Security Act of 1974
("ERISA").
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(C) EXHIBITS.
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
99.1 Cautionary Statements for Purposes of the Private Securities
Litigation Reform Act of 1995.
99.2 Federal Income Tax and ERISA Considerations.
</TABLE>
2
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
JDN REALTY CORPORATION
By: /s/ William J. Kerley
----------------------------------
William J. Kerley
Chief Financial Officer
Date: March 24, 1997
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
99.1 Cautionary Statements for Purposes of the Private
Securities Litigation Reform Act of 1995.
99.2 Federal Income Tax and ERISA Considerations.
</TABLE>
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EXHIBIT 99.1
CAUTIONARY STATEMENTS FOR PURPOSES OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
JDN Realty Corporation (the "Company") desires to take advantage of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995 (the "Act") and is filing this Form 8-K in order to do so. Many of the
important factors discussed below have been discussed in the Company's previous
SEC filings.
The Company wishes to caution readers that the following important
factors, among others, in the future could affect the Company's actual results
and could cause the Company's actual consolidated results from operations to
differ materially from those expressed in any forward-looking statements made
by or on behalf of the Company from time to time.
SIGNIFICANT RELIANCE ON MAJOR TENANTS
As of December 31, 1996, each of Wal-Mart and Lowe's leased more than
10% of the gross leaseable area owned directly by the Company ("Company GLA")
and accounted for more than 10% of the Company's total minimum rent. No other
single tenant accounts for more than 10% of Company GLA or more than 10% total
minimum rent in 1996. The Company could be adversely affected and
distributions could be reduced in the event of the bankruptcy or insolvency of,
or a downturn in the business of, either of such tenants, or if either of such
tenants is unable to pay its rent as it becomes due or does not renew its
leases as they expire.
DEPENDENCE ON AND INFLUENCE OF EXECUTIVE OFFICERS AND DIRECTORS
The Company is dependent on the efforts of its executive officers, and
particularly J. Donald Nichols and Elizabeth L. Nichols. The loss of their
services could have an adverse effect on the operations of the Company. J.
Donald Nichols and Elizabeth L. Nichols, each of whom is a director and an
executive officer, and the other directors and executive officers of the
Company have substantial influence on the affairs of the Company, including the
ability of the directors to amend the investment and financing policies of the
Company without a vote of the holders of the Common Stock. Any such amendments
could result in decisions that are detrimental to the value of the Company.
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RISK OF LEVERAGE AND DEFAULT; RISK OF BALLOON PAYMENTS OF DEBT
The Company is subject to the risks normally associated with debt
financing, including the risk that the Company's cash provided by operating
activities will be insufficient to meet required payments of principal and
interest, the risk that the Company will not be able to pay or refinance
indebtedness on its properties or that the terms of a refinancing will not be
as favorable as the terms of existing indebtedness.
If prevailing interest rates or other factors at the time of
refinancing result in higher interest rates on refinancing, the Company's
interest expense would increase, which would adversely affect the Company's
cash provided by operating activities and its ability to make distributions or
payments to holders of the Company's securities. In addition, in the event the
Company were unable to secure refinancing of such indebtedness on acceptable
terms, the Company might be forced to dispose of properties upon
disadvantageous terms, which might result in losses to the Company and might
adversely affect the Company's funds from operations. In addition, if a
property or properties are mortgaged to secure payment of indebtedness and the
Company is unable to meet mortgage payments, the property could be foreclosed
upon by or otherwise transferred to the mortgagee with a consequent loss of
income and asset value to the Company.
The Company's present policy prohibits incurring debt (secured or
unsecured) in excess of 60% of total market capitalization. This limitation
can be changed by the Board of Directors without approval of the holders of the
Common Stock. The Charter and Bylaws of the Company do not limit the amount of
borrowings the Company can incur.
GENERAL REAL ESTATE INVESTMENT RISKS
General. Real property investments are subject to varying degrees of
risk. Real estate values and the income generated from real estate investments
may be affected by a number of factors, including changes in the general
economic climate, local conditions (such as an oversupply of or a reduction in
demand for shopping center space in an area), the quality and philosophy of
management, competition from other available space, the ability of the owner to
provide adequate maintenance and insurance and variable operating costs
(including real estate taxes). Real estate values and the income from real
properties are also affected by such factors as the costs associated with
government regulations, interest rate levels, the availability of financing and
potential liability under and changes in environmental and other laws. Since
substantially all of the Company's income is derived from rental income from
real property, the Company's income would be adversely affected if a
significant number of the Company's tenants were unable to meet their
obligations to the Company, or if the Company were unable to lease on
economically favorable terms a significant amount of space in its properties.
In the event of default by a tenant, the Company may experience delays in
enforcing, and incur substantial costs to enforce, its rights as landlord. In
addition, certain significant expenditures associated with ownership of real
estate (such as mortgage payments, real estate taxes and maintenance costs) are
generally not reduced when circumstances cause a reduction in income from the
investment.
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Operating Risks. The Properties are subject to all operating risks
common to shopping center developments. Such risks include: competition from
other shopping center developments; excessive building of comparable properties
or increases in unemployment in the areas in which the Company's properties are
located, either of which might adversely affect occupancy or rental rates;
increases in operating costs due to inflation and other factors, which
increases may not necessarily be offset by increased rents; inability or
unwillingness of lessees to pay rent increases; and future enactment of laws
regulating public places, including present and possible future laws relating
to access by disabled persons. If operating expenses increase, the local
rental market may limit the extent to which rents may be increased to meet
increased expenses without decreasing occupancy rates. If any of the above
occurred, the Company's ability to make distributions or payments to holders of
its securities could be adversely affected.
Illiquidity of Real Estate. Equity real estate investments are
relatively illiquid and therefore may tend to limit the ability of the Company
to react promptly in response to changes in economic or other conditions.
Further, the Internal Revenue Code of 1986, as amended (the "Code"), places
limits on a REIT's ability to sell properties held for fewer than four years,
which may affect the Company's ability to sell properties without adversely
affecting returns to holders of the Company's securities.
Ability to Rent Unleased Space. The ability of the Company to rent
unleased space is affected by many factors, including certain covenants
restricting the use of other space at a property found in certain leases with
tenants in shopping centers. In addition, the Company may incur costs in
making improvements or repairs to a property required by a new tenant.
Effect of Uninsured Loss on Performance. The Company carries
comprehensive liability, fire, flood, extended coverage and rental loss
insurance with respect to its properties with policy specifications and insured
limits customarily carried for similar properties. There are, however, certain
types of losses (such as from wars or earthquakes) that are either uninsurable
or insurable only at costs which are not economically justifiable. Should an
uninsured loss occur, the Company could lose both its invested capital in, and
anticipated profits from, the property and would continue to be obligated to
repay any recourse mortgage indebtedness on the property.
Competition. There are numerous commercial developers, real estate
companies and other owners of real estate, including those that operate in the
region in which the Company's properties are located, that compete with the
Company in seeking land for development, properties for acquisition and tenants
for properties. Certain of these competitors may have greater capital and
other resources than the Company.
Potential Environmental Liability and Cost of Remediation. Under
various federal, state and local environmental laws, ordinances and
regulations, an owner of real property may be liable for the costs of removal
or remediation of certain hazardous or toxic substances at, under or disposed
of in connection with such property, as well as certain other potential costs
relating to hazardous or toxic substances (including government fines and
injuries to persons and adjacent property). These laws often impose such
liability without regard to whether the owner knew of,
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or was responsible for, the presence or disposal of such substances and may be
imposed on the owner in connection with the activities of an operator of the
property. The cost of any required remediation, removal, fines or personal or
property damages and the owner's liability therefor could exceed the value of
the property. In addition, the presence of such substances, or the failure to
properly dispose of or remediate such substances, may adversely affect the
owner's ability to sell or rent such property or to borrow using such property
as collateral which, in turn, would reduce the owner's revenues.
Americans with Disabilities Act. The Company's properties and any
additional developments or acquisitions must comply with Title III of the
Americans with Disabilities Act (the "ADA"). Compliance with the ADA's
requirements could require removal of structural, architectural or
communication barriers to handicapped access and utilization in certain public
areas of the Company's properties. Noncompliance could result in injunctive
relief, imposition of fines or an award of damages to private litigants. If
changes are required to bring any of the properties into compliance with the
ADA, the Company's ability to make expected distributions could be adversely
affected. The Company believes that its competitors face similar costs to
comply with the requirements of the ADA.
RISKS INHERENT IN DEVELOPMENT AND ACQUISITION ACTIVITIES
Developing or expanding existing shopping centers is an integral part
of the Company's strategy for maintaining and enhancing the value of its
shopping center portfolio. While the Company's policies with respect to its
activities are intended to limit some of the risks otherwise associated with
those activities (including not commencing construction on a project prior to
obtaining a commitment from an anchor tenant), the Company nevertheless will
incur certain risks, including risks related to delays in construction and
lease-up, costs of materials, financing availability, volatility in interest
rates, labor availability, and the failure of properties to perform as
expected.
LIMITATIONS ON POTENTIAL CHANGES IN CONTROL
Certain provisions of the Company's Charter and Bylaws and Maryland
law may make a change in the control of the Company more difficult, even if a
change of control were in the shareholders' interest. These provisions include
the limitation on ownership of the Company's capital stock by any single holder
(other than the Nichols, their immediate family and certain affiliates) to (a)
8% of either the number or the value of the outstanding shares of Common Stock
and (b) 8% of either the number or the value of the outstanding shares of
Preferred Stock, the staggered terms of the Company's Board of Directors,
super-majority voting and business combination provisions and the ability of
the Company's Board of Directors to issue Preferred Stock without shareholder
approval.
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ADVERSE CONSEQUENCES OF FAILURE TO QUALIFY AS A REIT
Tax Liabilities of Failure to Qualify as a REIT. The Company is
treated for federal income tax purposes as a REIT under the Code. No assurance
can be given that the Company will continue to operate in a manner enabling it
to remain so qualified. Qualification as a REIT involves the application of
highly technical and complex Code provisions which have only a limited number
of judicial or administrative interpretations, and the determination of various
factual matters and circumstances not entirely within the Company's control may
impact its ability to qualify as a REIT. In addition, no assurance can be
given that new legislation, regulations, administrative interpretations or
court decisions will not significantly change the tax laws with respect to the
qualification as a REIT or the federal income tax consequences of such
qualification.
If in any taxable year the Company does not qualify as a REIT, it
would be taxed as a corporation and distributions to the holders of the
Company's capital stock would not be deductible by the Company in computing its
taxable income. In addition, unless entitled to relief under certain statutory
provisions, the Company would also be disqualified from treatment as a REIT for
the four taxable years following the year during which qualification was lost.
This treatment would reduce the net earnings of the Company available for
investment or distribution or payment to holders of its securities because of
the additional tax liability to the Company for the year or years involved. In
addition, the Company would no longer be required by the Code to make any
distributions.
To qualify as a REIT, the Company will be required to distribute at
least 95% of its taxable income to its shareholders each year. Possible timing
differences between receipt of income and payment of expenses, and the
inclusion and deduction of such amounts in determining taxable income, could
require the Company to reduce its dividends below the level necessary to
maintain its qualification as a REIT, which would have material adverse tax
consequences.
Other REIT Taxes. Although qualified to be taxed as a REIT, certain
transactions or other events could lead to the Company being taxed at rates
ranging from 4% to 100% on certain income or gains.
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EXHIBIT 99.2
FEDERAL INCOME TAX AND ERISA CONSIDERATIONS
The Company believes that it has qualified and intends to remain
qualified to be taxed as a REIT for federal income tax purposes under Sections
856 through 860 of the Code, commencing with the taxable period beginning March
26, 1994 and ending December 31, 1994. The following discussion addresses the
material tax considerations relevant to the taxation of the Company and
summarizes certain federal income tax consequences that may be relevant to
certain shareholders. However, the actual tax consequences of holding
particular securities being issued by the Company may vary in light of a
prospective holder's particular facts and circumstances. Certain holders, such
as tax-exempt entities, insurance companies and financial institutions, are
generally subject to special rules. In addition, the following discussion does
not discuss issues under any foreign, state or local tax laws. The tax
treatment of a holder of any of the securities offered by the Company will vary
depending upon the terms of the particular securities acquired by such holder,
as well as his particular situation, and this discussion does not attempt to
address aspects of federal income taxation relating to holders of particular
securities. Any additional federal income tax considerations relevant to
holders of particular securities will be provided in the applicable Prospectus
and/or Prospectus Supplement relating thereto. Waller Lansden Dortch & Davis,
A Professional Limited Liability Company, has acted as tax counsel to the
Company in connection with this summary. This summary is qualified in its
entirety by the applicable Code provisions, rules and regulations promulgated
thereunder, and administrative and judicial interpretations thereof. No
rulings have been obtained or are expected to be obtained from the IRS
concerning any of the matters discussed herein. It should be noted that the
Code, rules, regulations, and administrative and judicial interpretations are
all subject to change (possibly on a retroactive basis).
EACH INVESTOR IS ADVISED TO CONSULT THE APPLICABLE PROSPECTUS AND/OR
PROSPECTUS SUPPLEMENT, AS WELL AS WITH HIS OWN TAX ADVISOR, REGARDING THE TAX
CONSEQUENCES TO HIM OF THE ACQUISITION, OWNERSHIP AND SALE OF THE COMPANY'S
SECURITIES, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX
CONSEQUENCES OF SUCH ACQUISITION, OWNERSHIP AND SALE AND OF POTENTIAL CHANGES
IN APPLICABLE TAX LAWS.
It is the opinion of Waller Lansden Dortch & Davis, A Professional
Limited Liability Company, that the Company is organized and is operating in
conformity with the requirements for qualification and taxation as a REIT
commencing with the Company's taxable year ending December 31, 1994, and its
method of operation will enable it to continue to meet the requirements for
qualification and taxation as a REIT under the Code. It must be emphasized
that this opinion is based on various assumptions and is conditioned upon
certain representations made by the Company as to factual matters including,
but not limited to, those set forth below in this discussion and those
concerning its business and properties as set forth in any applicable
Prospectus and/or Prospectus Supplement. Moreover, such qualification and
taxation as a REIT depends upon the Company's ability to meet, through actual
annual operating results, the various income, asset,
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distribution, stock ownership and other tests discussed below, the results of
which will not be reviewed by Waller Lansden Dortch & Davis, A Professional
Limited Liability Company. Accordingly, no assurance can be given that the
actual results of the Company's operations for any one taxable year will
satisfy such requirements.
If the Company initially failed to elect or qualify for taxation as a
REIT or ceases to qualify as a REIT, and the relief provisions do not apply,
the Company's income that is distributed to shareholders would be subject to
the "double taxation" on earnings (once at the corporate level and again at the
shareholder level) that generally results from investment in a corporation.
Failure to qualify and to maintain qualification as a REIT would force the
Company to reduce significantly its distributions and possibly incur
substantial indebtedness or liquidate substantial investments in order to pay
the resulting corporate taxes. In addition, the Company, once having obtained
REIT status and having lost such status, would not be eligible to elect REIT
status for the four subsequent taxable years, unless its failure to maintain
its qualification was due to reasonable cause and not willful neglect, and
certain other requirements were satisfied. In order to elect to again be taxed
as a REIT, just as with the original election, the Company would be required to
distribute all of its earnings and profits accumulated in any non-REIT taxable
year.
The Company intends to conduct its affairs so that the assets of the
Company will not be deemed to be "plan assets" of any individual retirement
account, employee benefit plan subject to Title I of ERISA, or other qualified
retirement plan subject to Section 4975 of the Code which acquires its shares.
The Company believes that, under present law, its distributions do not create
so called "unrelated business taxable income" to tax-exempt entities such as
pension trusts, subject, however, to certain rules which, generally, apply to a
REIT predominantly owned by pension trusts each holding more than 10% of such
REIT's shares or to a REIT which is at least 25% owned by a single pension
trust. The Company does not believe that these special rules currently apply
to the Company's distributions.
TAXATION OF THE COMPANY
If the Company qualifies for taxation as a REIT, it generally will not
be subject to federal income taxes on that portion of its ordinary income or
capital gain that is currently distributed to shareholders.
However, the Company will be subject to federal income tax as follows:
First, the Company will be taxed at regular corporate rates on any
undistributed "real estate investment trust taxable income," including
undistributed net capital gains. Second, under certain circumstances, the
Company may be subject to the "alternative minimum tax" on its items of tax
preference, if any. Third, if the Company has (i) net income from the sale or
other disposition of "foreclosure property" that is held primarily for sale to
customers in the ordinary course of business, or (ii) other nonqualifying
income from foreclosure property, it will be subject to tax on such income at
the highest corporate rate. Fourth, any net income that the Company has 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) will be subject to a 100%
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tax. Fifth, if the Company should fail to satisfy either the 75% or 95% gross
income tests (as discussed below), and has nonetheless maintained its
qualification as a REIT because certain other requirements have been met, it
will be subject to a 100% tax on the net income attributable to the greater of
the amount by which the Company fails the 75% or 95% gross income tests.
Sixth, if the Company fails to distribute during each year at least the sum of
(i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT capital
gain net income for such year, and (iii) any undistributed taxable income from
preceding periods, then the Company will be subject to a four percent excise
tax on the excess of such required distribution over the amounts actually
distributed. Seventh, to the extent that the Company recognizes gain from the
disposition of an asset with respect to which there existed "built-in gain" as
of January 1, 1994 and such disposition occurs within a 10-year recognition
period beginning January 1, 1994, the Company will be subject to federal income
tax at the highest regular corporate rate on the amount of its "net recognized
built-in gain." The Company estimates that on January 1, 1994, the aggregate
"built-in gain" was approximately $12.1 million. The Company may offset any
net recognized built-in gain by available net operating loss carryforwards. On
January 1, 1994, the Company had approximately $2.7 million in net operating
loss carryforwards which expire at various dates through 2007. As a part of
the formation transactions effectuated in connection with its initial public
offering, the Company exchanged certain parcels of land for other real property
with J. Donald Nichols. In the event the IRS disqualifies that like-kind
exchange, the Company could incur built-in gains tax. Management of the
Company will consider this tax effect when determining whether it is in the
best interest of the Company to sell a specific piece of real property.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify as a REIT for a taxable year under the Code, the Company
must have no earnings and profits accumulated in any non-REIT year. The
Company also must have in effect an election to be taxed as a REIT and must
meet other requirements, some of which are summarized below, including
percentage tests relating to the sources of its gross income, the nature of the
Company's assets and the distribution of its income to shareholders. Such
election, if properly made and assuming continuing compliance with the
qualification tests described herein, will continue in effect for subsequent
years.
ORGANIZATIONAL REQUIREMENTS AND SHARE OWNERSHIP TESTS
Section 856(a) of the Code defines a REIT as a corporation, trust or
association; (1) which 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) which would be taxable,
but for Sections 856 through 860 of the Code, as an association taxable as a
domestic corporation; (4) which 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, determined without reference
to any rules of attribution (the "share ownership test"); (6) that during the
last half of each taxable year not more than 50% in value of the outstanding
stock of which is owned, directly or indirectly, by five or fewer individuals
(as defined in the Code to include certain
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entities) (the "five or fewer test"); and (7) which meets certain other tests,
described below, regarding the nature of its income and assets.
Section 856(b) of the Code provides that conditions (1) through (4),
inclusive, must be met during the entire taxable year and that condition (5)
must be met during at least 335 days of a taxable year of 12 months, or during
a proportionate part of a taxable year of fewer than 12 months. The "five or
fewer test" and the share ownership test do not apply to the first taxable year
for which an election is made to be treated as a REIT.
The Company has issued sufficient shares to a sufficient number of
people pursuant to its initial public offering to allow it to satisfy the share
ownership test and the five or fewer test. In addition, to assist in complying
with the five or fewer test, the Company's Charter contains certain provisions
restricting share transfers where the transferee (other than the Nichols,
members of their families and certain affiliates, and certain exceptions
specified in the Charter) would, after such transfer, own (a) more than 8%
either in number or value of the outstanding Common Stock of the Company or (b)
more than 8% either in number or value of the outstanding Preferred Stock of
the Company. Pension plans and certain other tax exempt entities will have
different restrictions on ownership. If, despite this prohibition, stock is
acquired increasing a transferee's ownership to over 8% in value of either the
outstanding Common Stock of the Company or Preferred Stock of the Company, the
stock in excess of the 8% is deemed to be held in trust for transfer at a price
which does not exceed what the purported transferee paid for the stock and,
while held in trust, the stock is not entitled to receive dividends or to vote.
In addition, under these circumstances, the Company also has the right to
redeem such stock.
Under the Revenue Reconciliation Act of 1993, for purposes of
determining whether the "five or fewer test" (but not the share ownership test)
is met, any stock held by a qualified trust (generally pension plans,
profit-sharing plans and other employee retirement trusts) generally is treated
as held directly by the trust's beneficiaries in proportion to their actuarial
interests in the trust, and not held by the trust.
INCOME TESTS
In order to maintain qualification as a REIT, three gross income
requirements must be satisfied annually. First, at least 75% of the Company's
gross income (excluding gross income from certain sales of property held
primarily for sale) must be derived directly or indirectly from investments
relating to real property (including "rents from real property") or mortgages
on real property. When the Company receives new capital in exchange for its
shares (other than dividend reinvestment amounts) or in a public offering of
debt instruments with maturities of five years or longer, income attributable
to the temporary investment of such new capital, if received or accrued within
one year of the Company's receipt of the new capital, is qualifying income
under the 75% test. Second, at least 95% of the Company's gross income
(excluding gross income from certain sales of property held primarily for sale)
must be derived from such real property investments, dividends, interest,
certain payments under interest rate swap or cap agreements, and gain from the
sale or other disposition of stock, securities not held for sale in the
ordinary course of business or
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from any combination of the foregoing. Third, short-term gain from the sale or
other disposition of stock or securities, including, without limitation,
dispositions of interest rate swap or cap agreements, and gain from certain
prohibited transactions or from other dispositions of real property and
mortgages on real property held for less than four years (apart from
involuntary conversions and sales of foreclosure property) must represent less
than 30% of the Company's gross income. (This rule does not apply for a year
in which the REIT is completely liquidated, as to dispositions occurring after
the adoption of a plan of complete liquidation.) For purposes of these rules,
income derived from a "shared appreciation provision" in a real estate backed
mortgage is treated as gain recognized on the sale of the property to which it
relates.
The Company may temporarily invest its working capital in short-term
investments, including shares in other REITs or interests in REMICs. Although
the Company will use its best efforts to ensure that its income generated by
these investments will be of a type which satisfies the 75% and 95% gross
income tests, there can be no assurance in this regard (see the discussion
above of the "new capital" rule under the 75% gross income test). Moreover,
the Company may realize short-term capital gain upon sale or exchange of such
investments, and such short-term capital gain would be subject to the
limitations imposed by the 30% gross income test. The Company has analyzed its
gross income through December 31, 1996 and has determined that it has met and
generally expects to meet in the future the 75% and 95% gross income tests
through the rental of the property it has and acquires, and by monitoring the
sale of assets has not and does not expect to violate the 30% gross income
test.
In order to qualify as "rents from real property," the amount of rent
received generally must not be based on the income or profits of any person,
but may be based on a fixed percentage or percentages of receipts or sales.
The Code also provides that rents will not qualify as "rents from real
property," in satisfying the gross income tests, if the REIT owns ten percent
or more of the tenant, whether directly or under certain attribution rules.
The Company leases and intends to lease property only under circumstances such
that substantially all, if not all, rents from such property qualify as "rents
from real property." Although it is possible that a tenant could sublease
space to a sublessee in which the Company is deemed to own directly or
indirectly ten percent or more of the tenant, the Company believes that as a
result of the provisions in the Charter limiting ownership to eight percent
such occurrence would be unlikely. Application of the ten percent ownership
rule is, however, dependent upon complex attribution rules provided in the Code
and circumstances beyond the control of the Company. Ownership, directly or by
attribution, by an unaffiliated third party of more than ten percent of the
Company's stock and more than ten percent of the stock of any lessee or
sublessee would result in a violation of the rule.
In order to qualify as "interest on obligations secured by mortgages
on real property," the amount of interest received generally must not be based
on the income or profits of any person, but may be based on a fixed percentage
or percentages of receipts or sales.
In addition, the Company must not manage its properties or furnish or
render services to the tenants of its properties, except through an independent
contractor from whom the Company derives no income. There is an exception to
this rule permitting a REIT to perform directly certain
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"usually or customarily rendered "tenant services of the sort which a
tax-exempt organization could perform without being considered in receipt of
"unrelated business taxable income." The Company self-manages the properties,
but does not provide services to tenants which it believes are outside the
exception.
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." Generally, this 15% test is applied
separately to each lease. The portion of rental income treated as attributable
to personal property is determined according to the ratio of the tax basis of
the personal property to the total tax basis of the property which is rented.
The determination of what fixtures and other property constitute personal
property for federal tax purposes is difficult and imprecise. Based upon
allocations of value as found in the purchase agreements and/or upon review by
employees of the Company, the Company currently does not have and does not
believe that is likely in the future to have 15% in value of any of its real
properties classified as personalty. Waller Lansden Dortch & Davis, A
Professional Limited Liability Company, in rendering its opinion as to the
qualification of the Company as a REIT, is relying on the allocations found in
the purchase agreements and/or the conclusions of the Company and its senior
management as to the proportionate value of the personalty. If, however, rent
payments do not qualify, for reasons discussed above, as rents from real
property for purposes of Section 856 of the Code, it will be more difficult for
the Company to meet the 95% or 75% gross income tests and continue to qualify
as a REIT.
The Company is and expects to continue performing third-party
management services. Such income does not qualify for the 95% or 75% test and
the Company will continue to monitor the volume of such income to avoid
violating the 95% and 75% gross income tests. The Company may, if necessary,
provide such services through an affiliated entity to avoid failing to satisfy
either the 95% or 75% gross income test. The Company presently has an
affiliated entity which is engaged in development activities.
If the Company fails 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 is entitled to relief under certain provisions of the Code.
These relief provisions will be generally available if the Company's failure to
meet such tests was due to reasonable cause and not to willful neglect, the
Company attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to know whether the Company would be
entitled to the benefit of these relief provisions as the application of the
relief provisions is dependent on future facts and circumstances. If these
relief provisions apply, a special tax generally equal to 100% is imposed upon
the net income attributable to the greater of the amount by which the Company
failed the 75% or 95% gross income tests.
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ASSET TESTS
At the close of each quarter of the Company's taxable year, it must
also satisfy three tests relating to the nature of its assets. First, at least
75% of the value of the Company's total assets must consist of real estate
assets (including interests in real property and interests in mortgages on real
property as well as its allocable share of real estate assets held by joint
ventures or partnerships in which the Company participates), cash, cash items
and government securities. Second, not more than 25% of the Company's total
assets may be represented by securities other than those includable in the 75%
asset class. Finally, of the investments included in the 25% asset class, the
value of any one issuer's securities owned by the Company may not exceed five
percent of the value of the Company's total assets, and the Company may not own
more than ten percent of any one issuer's outstanding voting securities. The
Company, however, may own 100% of the stock of a corporation if such stock is
held by the Company at all times during such subsidiary's existence. Such a
subsidiary is called a "qualified REIT subsidiary". Under that circumstance,
the qualified REIT subsidiary is ignored and the assets, income, gain, loss and
other attributes are treated as being owned or generated directly by the
Company for federal tax purposes. The Company currently has two wholly owned
qualified REIT subsidiaries.
If the Company meets the 25% requirement at the close of any quarter,
it will not lose its status as a REIT because of the change in value of its
assets unless the discrepancy exists immediately after the acquisition of any
security or other property which is wholly or partly the result of an
acquisition during such quarter. Where a failure to satisfy the 25% asset test
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 such quarter. The Company maintains and
intends to continue to maintain adequate records of the value of its assets to
maintain compliance with the 25% asset test, and to take such action as may be
required to cure any failure to satisfy the test within 30 days after the close
of any quarter.
In order to qualify as a REIT, the Company is required to distribute
dividends (other than capital gain dividends) to its shareholders in an amount
equal to or greater than the excess of (A) the sum of (i) 95% of the Company's
"real estate investment trust taxable income" (computed without regard to the
dividends paid deduction and the Company's net capital gain) and (ii) 95% of
the net income, if any, (after tax) from foreclosure property, over (B) the sum
of certain non-cash income (from certain imputed rental income and income from
transactions inadvertently failing to qualify as like-kind exchanges). These
requirements may be waived by the IRS if the REIT establishes that it failed to
meet them by reason of distributions previously made to meet the requirements
of the four percent excise tax described below. To the extent that the Company
does not distribute all of its net long-term capital gain and all of its "real
estate investment trust taxable income," it will be subject to tax thereon. In
addition, the Company will be subject to a four percent excise tax to the
extent it fails within a calendar year to make "required distributions" to its
shareholders of 85% of its ordinary income and 95% of its capital gain net
income plus the excess, if any, of the "grossed up required distribution" for
the preceding calendar year over the amount treated as distributed for such
preceding calendar year. For this purpose, the term "grossed up required
distribution" for any calendar year is the sum of the taxable income of the
Company
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<PAGE> 8
for the taxable year (without regard to the deduction for dividends paid) and
all amounts from earlier years that are not treated as having been distributed
under the provision. Dividends declared in the last quarter of the year and
paid during the following January will be treated as having been paid and
received on December 31.
It is possible that the Company, from time to time, may not have
sufficient cash or other liquid assets to meet the 95% distribution
requirements due to timing differences between actual receipt of income and
actual payment of deductible expenses or dividends on the one hand and the
inclusion of such income and deduction of such expenses or dividends in
arriving at "real estate investment trust taxable income" of the Company on the
other hand. The problem of inadequate cash to make required distributions
could also occur as a result of the repayment in cash of principal amounts due
on the Company's outstanding debt, particularly in the case of "balloon"
repayments or as a result of capital losses on short-term investments of
working capital. Therefore, the Company might find it necessary to arrange for
short-term, or possibly long-term borrowing, or new equity financing. If the
Company were unable to arrange such borrowing or financing as might be
necessary to provide funds for required distributions, its REIT status could be
jeopardized.
Under certain circumstances, the Company 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 the
Company's deduction for dividends paid for the earlier year. The Company may
be able to avoid being taxed on amounts distributed as deficiency dividends;
however, the Company may in certain circumstances remain liable for the four
percent excise tax described above.
The Company is also required to request annually (within 30 days after
the close of the REIT's taxable year) from record holders of certain
significant percentages of its shares certain written information regarding the
ownership of such shares. A list of shareholders failing to fully comply with
the demand for the written statements shall be maintained as part of the
Company's records required under the Code. Rather than responding to the
Company, the Code allows the shareholder to submit such statement to the IRS
with the shareholder's tax return. The Company's Bylaws require such record
holders to respond to such requests for information.
FEDERAL INCOME TAX TREATMENT OF LEASES
The availability to the Company of, among other things, depreciation
deductions with respect to the facilities owned and leased by the Company
depends upon the treatment of the Company as the owner of the facilities and
the classification of the leases of the facilities as true leases, rather than
as sales or financing arrangements, for federal income tax purposes. The
Company has not requested nor received an opinion that it will be treated as
the owner of the portion of the facilities constituting real property and the
leases will be treated as true leases of such real property for federal income
tax purposes. Based on the conclusions of the Company and its senior
management as to the values of personalty, the Company has met and plans to
meet in the future its compliance with the 95% distribution requirement (and
the required distribution
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<PAGE> 9
requirement) by making distributions on the assumption that it is not entitled
to depreciation deductions for that portion of the leased facilities which it
believes constitutes personal property, but to report the amount of income
taxable to its shareholders by taking into account such depreciation. The
value of real and personal property and whether certain fixtures are real or
personal property are factual evaluations that cannot be determined with
absolute certainty under current IRS regulations and therefore are somewhat
uncertain.
OTHER ISSUES
With respect to property acquired from and leased back to the same or
an affiliated party, the IRS could assert that the Company realized prepaid
rental income in the year of purchase to the extent that the value of the
leased property exceeds the purchase price paid by the Company for that
property. In litigated cases involving sale-leasebacks which have considered
this issue, courts have concluded that buyers have realized prepaid rent where
both parties acknowledged that the purported purchase price for the property
was substantially less than fair market value and the purported rents were
substantially less than the fair market rentals. Because of the lack of clear
precedent and the inherently factual nature of the inquiry, complete assurance
cannot be given that the IRS could not successfully assert the existence of
prepaid rental income in such circumstances. The value of property and the
fair market rent for properties involved in sale-leasebacks are inherently
factual matters and always subject to challenge.
Additionally, it should be noted that Section 467 of the Code
(concerning leases with increasing rents) may apply to those leases of the
Company which provide for rents that increase from one period to the next.
Section 467 provides that in the case of a so-called "disqualified leaseback
agreement," rental income must be accrued at a constant rate. If such constant
rent accrual is required, the Company would recognize rental income in excess
of cash rents and as a result, may fail to meet the 95% dividend distribution
requirement. "Disqualified leaseback agreements" include leaseback
transactions where a principal purpose of providing increasing rent under the
agreement is the avoidance of federal income tax. Because Section 467 directs
the Treasury to issue regulations providing that rents will not be treated as
increasing for tax avoidance purposes where the increases are based upon a
fixed percentage of lessee receipts additional rent provisions of leases
containing such clauses should not be "disqualified leaseback agreements." In
addition the legislative history of Section 467 indicates that the Treasury
should issue regulations under which leases providing for fluctuations in rents
by no more than a reasonable percentage from the average rent payable over the
term of the lease will be deemed not motivated by tax avoidance; this
legislative history indicates that a standard allowing a ten percent
fluctuation in rents may be too restrictive for real estate leases. It should
be noted, however, that leases involved in sale-leaseback transactions are
subject to special scrutiny under this Section. The Company, based on its
evaluation of the value of the property and the terms of the leases, does not
believe it has or will have in the future rent subject to the provisions of
Section 467.
Subject to a safe harbor exception for annual sales of up to seven
properties (or properties with a basis of up to 10% of the REIT's assets) that
have been held for at least four years, gain from sales of property held for
sale to customers in the ordinary course of business is subject to
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<PAGE> 10
a 100% tax. The simultaneous exercise of options to acquire leased property
that may be granted to certain lessees or other events could result in sales of
properties by the Company that exceed this safe harbor. However, the Company
believes that in such event, it will not have held such properties for sale to
customers in the ordinary course of business.
DEPRECIATION OF PROPERTIES
For tax purposes, the Company's real property acquired subsequent to
its initial public offering will be depreciated over 40 years and personal
property over seven years utilizing the straight-line method of depreciation.
The Company's existing real property will be depreciated over the remaining
lives and in accordance with the method being used by the Company prior to the
initial public offering.
FAILURE TO QUALIFY AS A REIT
If the Company fails to qualify for federal taxation purposes as a
REIT in any taxable year, and the relief provisions do not apply, the Company
will be subject to tax on its taxable income at regular corporate rates (plus
any applicable alternative minimum tax). Distributions to shareholders in any
year in which the Company fails to qualify will not be deductible by the
Company nor will they be required to be made. In such event, to the extent of
current or accumulated earnings and profits, all distributions to shareholders
will be taxable as ordinary income and, subject to certain limitations in the
Code, eligible for the 70% dividends received deductions for corporate
shareholders. Unless entitled to relief under specific statutory provisions,
the Company will also be disqualified from taxation as a REIT for the following
four taxable years. It is not possible to state whether in all circumstances
the Company would be entitled to statutory relief from such disqualification.
Failure to qualify for even one year could result in the Company's incurring
substantial indebtedness (to the extent borrowings are feasible) or liquidating
substantial investments in order to pay the resulting taxes.
FOREIGN SHAREHOLDERS
In general, each foreign corporation, partnership and nonresident
alien individual that does not hold its, his or her shares of the Company's
capital stock in connection with the conduct of a United States trade or
business will be subject to a 30% tax (or lesser amount, as provided by an
applicable income tax treaty) on all ordinary dividends paid with respect to
such shares. The Company will be required to withhold and pay over such tax.
If a foreign shareholder holds such shareholder's shares in connection with the
conduct of a United States trade or business, and provides the Company with a
properly executed Form 4224, such shareholder will be subject to tax on
ordinary dividends in the same manner as a United States person and the REIT
will not withhold any distributions to such shareholder. Distributions in
excess of current and accumulated earnings and profits of the Company will not
be taxable to a non-U.S. shareholder to the extent they do not exceed the
adjusted basis of the shareholder's shares. Rather, such distributions will
reduce the adjusted basis of such shares, but not below zero. To the extent
that such distributions exceed the adjusted basis of a non-U.S. shareholder's
shares, they will give rise to tax liability if
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<PAGE> 11
the non-U.S. shareholder would otherwise be subject to tax on any gain from the
sale or disposition of the shares as described below. If, at the time the
distribution was made, it cannot be determined whether the distribution will be
in excess of current and accumulated earnings and profits, the distribution
will be subject to withholding at the same rate as a dividend. Such amounts
would, however, be refundable if it is subsequently determined that such
distribution was in excess of current and accumulated earnings and profits of
the Company.
To the extent a foreign shareholder receives distributions
attributable to the sale or exchange of United States real property interests
held by the Company, each foreign shareholder will be treated as having engaged
in a United States trade or business and, therefore, will be subject to United
States federal income tax in the same manner as a United States person on such
distributions. The Company (or the United States nominee of a foreign
shareholder) must withhold 34% of all distributions to a foreign shareholder
attributable to the disposition of United States real property interests which
are designated as capital gain dividends, unless the foreign shareholder has
provided the Company (or the shareholder's United States nominee) with a
statement claiming a withholding exemption from the Internal Revenue Service.
A foreign shareholder will be entitled to a credit against United States income
tax equal to the amount so withheld.
Generally, a foreign person will not be subject to United States
income tax on any gain recognized upon a sale or exchange of such person's
shares of the Company's capital stock. If, however, the Company does not
qualify as a "domestically controlled REIT," a non-U.S. shareholder will be
subject to tax on gain recognized upon the sale of the shares. A domestically
controlled REIT is defined as a REIT in which at all times during a specified
testing period less than 50% in number or value of the shares are held directly
or indirectly by foreign persons. It is anticipated that the Company will
qualify as a domestically controlled REIT. Non-U.S. shareholders will also be
taxed on gain recognized from the sale of their shares in the Company if (i)
the investment in such shares is effectively connected with the non-U.S.
shareholder's United States trade or business, in which case a 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 non-resident alien 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 non-resident alien will be subject
to a 30% tax on the individual's capital gain.
Foreign persons contemplating an investment in the Company's
securities should consult their home country tax advisors concerning the tax
treatment of such investment under their home country laws, including their
ability, if any, to obtain a tax credit for any United States taxes paid.
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