REIT CONVERSIONS AND REORGANIZATIONS AND COMPARISON OF VARIOUS INVESTMENT STRUCTURES January 22, 2015 Robert A.N. Cudd

Polsinelli PC. In California, Polsinelli LLP

Selection of Entity for Holding Real Estate Generally, taxpayers prefer to hold real estate through a tax efficient entity that avoids corporate level tax, such as a partnership or REIT. − A partnership or LLC is not subject to corporate level tax unless it is treated as a publicly traded partnership under Section 7704 or elects to be treated as a corporation. − REITs are treated as corporations but can deduct dividends paid to shareholders. − C corporations will not be subject to corporate level tax if they have no taxable income and distributions to shareholders will not be dividends if the corporation has no current or accumulated earnings and profits. − Certain utilities have sponsored Yieldcos, formed as C corporations, to hold alternative energy properties generating depreciation deductions and tax credits. Generally, the Yieldcos have little or no taxable income or earnings and profits.

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Selection of Entity for Holding Real Estate − C corporations may also serve as “blockers” for foreign investors or tax-exempt organizations investing in partnerships to avoid unrelated business income (UBTI) or unrelated debt financial income (UDFI) which they would realize if they owned a direct interest in the partnership. − Foreign investors may prefer holding partnership interests through a “blocker” corporation to avoid U.S. Federal income tax filing requirements. − Partnership structures can combine domestic (U.S.) or foreign corporations to provide flexibility for both foreign and U.S. investors. − Master Limited Partnerships can continue to qualify as partnerships even if they are publicly traded as long as 90% of their gross income is qualifying income.

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Basic Partnership and Blocker Structures Since the blocker is a corporation, any UBTI or or UDFI realized by the blocker does not “flow through” to a tax-exempt entity. –

The blocker limits the types of income realized by a tax-exempt entity to dividends from the blocker and gains on the sale of stock of the blocker, which the tax-exempt entity can receive free from U.S. Federal income tax.

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If the types of income generated by the partnership fund are limited to interest income not subject to U.S. withholding tax because of the portfolio interest exemption and capital gains, the investor’s allocable share of such income will not be subject to Federal income or withholding tax and a blocker corporation may not be required.

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Assuming that the blocker is organized in a tax-haven jurisdiction such as the Cayman Islands, no tax should be imposed on the blocker or on payments made by the blocker. Alternatively, a domestic (U.S.) corporation could be used and capitalized with debt to reduce corporate level taxes.

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Basic Partnership and Blocker Structures Use of a corporate blocker eliminates the need for non-U.S. investors to file U.S. tax returns as a result of investing in the fund. If the partnership has business operations in the U.S., the blocker may be treated as engaged in a U.S. trade or business. A partner of a partnership is treated as engaging in a U.S. trade or business to the extent the partnership in which it is a partner is so engaged. − In addition, if the blocker realizes gain or loss from the disposition of a “U.S. real property interest,” it will be treated as engaging in a U.S. trade or business, and such gain or loss will be treated as effectively connected to the U.S. trade or business. − If the blocker is treated as engaging in a U.S. trade or business, the blocker will be subject to U.S. Federal income tax at the regular rates on the partnership’s income and gain from the sale of its interest in the partnership and may be subject to a “branch profits” tax if the blocker is a foreign corporation.

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Master Feeder Structure with U.S. and Foreign Investor

L.P.s (U.S. Taxable Investors)

GP U.S. LLC

U.S. Feeder Partnership for U.S. Tax Purposes)

Investors (U.S. tax-exempt and Non-U.S.)

GP U.S. LLC

Domestic (U.S.) or Foreign Company (Corporation for U.S. Tax Purposes)

Master Fund (Partnership for U.S. Tax Purposes)

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UPREIT Structure REITS often hold their real estate through an operating partnership (“OP”) which allows taxpayers to contribute real estate to the partnership on a taxdefined basis. The Op Units are redeemable for cash or convertible into REIT shares at the option of the REIT. − The UPREIT structure allows the REIT to qualify as a REIT but provides flexibility for contributions, carried interests and “profits” interests.

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REIT Structure Under Treasury Regulations Section 1. 856-3(g), the REIT is deemed to own its proportionate share of each of the assets and each item of income from the partnership. – Thus, the character of the assets and income in the hands of the partnership retain the same character in the hands of the REIT. The REIT’s proportionate interest is based on its capital interest in the partnership. – The key limitation on the use of a REIT is that 75% of its assets and income must be derived from “real estate assets” as defined in Section 856(c) of the Code. – Generally, an equity REIT satisfies the 75% real estate assets requirement through qualifying rents from “real estate assets.” Alternatively, a REIT can satisfy the 75% requirement by investing in debt obligations secured by real estate and interests in real estate, in which case the interest income is treated as derived from real estate assets and the mortgage debt instrument is treated as a “real estate asset.” – REITs may also establish taxable REIT subsidiaries (“TRS”) as long as the value of the TRS’s do not exceed 25% of the value of its total assets.

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UPREIT Structure Basic Structure

REIT Managing Partner A Member

Operating Partnership

Investors Exchangeable OP Units

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UPREIT Structure The UPREIT structure can be combined with a separate partnership structure in a DownREIT structure which permits investors to retain an interest in specific partnership assets. – UPREIT and DownREIT structures offer certain advantages and have certain disadvantages in comparison with blocker and simple partnership structures. – For example, the UPREIT and DownREIT structures permit investors to contribute property in exchange for OP Units on a tax-deferred basis. – Partnership attributes permit special allocations, “profits” interests and flexible business and management arrangements.

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UPREIT and DownREIT Structures

U.S. Taxable Investors

U.S. Taxable Investors Op Units Exchangeable for REIT Shares

U.S. Taxable Investors Op Units Exchangeable for REIT Shares

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Advantages in Using a REIT vs. Blocker Structure There is a risk in using a blocker that it will be treated as being engaged in a U.S. trade or business (or having a U.S. permanent establishment under an applicable tax treaty) by virtue of investing in the partnership and consequently will be subject to net U.S. Federal taxation and the imposition of the branch profits tax. There is a risk of withholding tax imposed on income earned by a partnership allocable to the blocker that is not interest eligible for the portfolio interest exemption or gains that would be an additional tax drag for tax-exempt investors. Many blockers are capitalized with debt to reduce the corporate level tax.

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Advantages in Using a REIT vs. Blocker Structure Dividends by REITs to tax-exempt entities and sale of REIT shares by taxexempt entities are generally not subject to UBTI unless a qualified trust owns more than 10% of a pension-held REIT. Foreign investors will not be treated as being engaged in a U.S. trade or business (or having a U.S. permanent establishment under an applicable tax treaty) by virtue of investing in a REIT and consequently will not be subject to net U.S. Federal taxation and the imposition of the branch profits tax on the income. Exception from the FIRPTA rules for foreign investors that own less than 5% of publicly-traded REIT or for gain on sale of stock of a domestically controlled REIT. REITs offer greater liquidity to investors. Foreign investors are not required to file U.S. tax returns with respect to REIT income but there may be withholding taxes. 13 real challenges. real answers. sm

Disadvantages in Using a REIT vs. Blocker Structure Some of the disadvantages of a REIT structure include: – Complexity of compliance with REIT rules and corporate treatment of fund if it fails to comply with REIT rules. – Limitation on investments to satisfy the REIT asset test. – Need for greater than 100 shareholders and prohibition on concentrated stock ownership of REIT. – 100% tax on gains from prohibited transactions. – Losses of REIT do not flow through to shareholders.

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Definition of Real Estate for REITs The most important factor in qualifying for REIT status is the definition of real property since as noted at least 75% of the assets and gross income must consist of or be derived from real property or interests in real property under Section 856(c)(5)(C). The definition of real property for REIT purposes has been expanded beyond the traditional view of real estate. On May 9, 2014, the Internal Revenue Service issued Proposed Treasury Regulations Section 1.856-10 under Section 856(c)(5)(C) of the Code relating to the definition of real property for purposes of the REIT provisions of the Code.

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Definition of Real Estate for REITs Proposed Treasury Regulations Section 1.856-10 (the “Proposed Regulation”) defines real estate as consisting of 3 different types of assets: land, improvements to land, and intangible assets. As under the current Treasury Regulations, improvements to land include inherently permanent structures and structural components of inherently permanent structures. Each distinct asset to be classified as real estate is either listed as an inherently permanent structure or structural component or must satisfy a facts and circumstances test. The asset can be used in connection with the operations of a business but must be passive in function.

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Definition of Real Estate for REITs The Proposed Regulation adopts current revenue rulings and private letter rulings. – Among other things, towers, telephone poles, parking facilities, pipelines, drilling platforms, storage structures, wharves and docks and outdoor advertising displays. – The Proposed Regulation recognizes that a solar energy site may qualify as real property, except for the PV Modules themselves since they perform an active function and are not inherently permanent structures. – The Proposed Regulation specifically confirms that intangible assets, such as goodwill, land use permits or other permits for the use, enjoyment of land, qualify as real estate. However, a permit to operate a business, such as the right to operate a casino in a building would not qualify as real property.

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Definition of Real Estate for REITs – The new distinct asset approach is designed to remove the uncertainty in the current Treasury Regulations whether certain assets that are permanent structures or components thereof are not real estate because they are used in the operation of a business. The Proposed Regulation deletes the “operation in connection with a business” rule and adds a new analytical tool based on the distinct asset concept which must either be an inherently permanent structure or component thereof and serve a passive as opposed to an active function. – The distinct asset must serve a passive function related to real property or inherently permanent structure or as a component of that structure’s passive function. If an asset has an active function, such as an asset that produces or manufactures a product, or contributes to the production of income other than consideration of its use or occupancy of space, it will not be classified as real property.

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Definition of Real Estate for REITs The examples of the Proposed Regulation illustrate its scope. – Under Example 1, natural products of land such as unsevered plants are real estate and cease to be real estate when they are severed. Boat slips and end ties in a marina qualify as land under Example 2. Indoor sculpture qualifies as an inherently permanent structure in Example 3 since the building was specifically designed to support the sculpture and removal of the sculpture would destroy it, and the sculpture does not serve any active function by producing any revenue. Example 4 concludes that bus shelters are not inherently permanent structures because they can be unbolted from the sidewalk, and do not meet the definition of buildings. – In Example 5, customized freezer walls and a central refrigeration system qualify as structural components of the warehouse building. – Example 6 analyzes a data center and concludes that the customized central heating and air conditioning system, the electrical system and telecommunications infrastructure system are structured components of the building since they are designed to remain permanently in place. – In example 7, modular partitions designed to delineate space between tenants are not structural components since they can be easily moved. 19 real challenges. real answers. sm

Definition of Real Estate for REITs – In Example 8, the components of a solar site including the racks, mounts, exit wiring are distinct assets which qualify as inherently permanent structures, but the PV modules are not structural components since they can be moved and serve an active function by converting sun into electricity which produces revenue. Example 9 analyzes a solar powered building and concludes that the entire energy site designed to power an adjacent building including the PV modules qualifies as a structural component since it serves a passive function for the building and is limited to that building. – In Example 10, a pipeline transmission system consisting of pipelines and storage tanks are listed as inherently permanent structures as are the valves to control oil flow, but meters and compressors to measure the oil flow are not structural components. – Example 11 concludes that goodwill related to a hotel building owned by a corporation is real property because it would be included in the basis of the hotel for Federal income tax purposes if the REIT had purchased the assets of the corporation. In Example 12, a special use permit from the government to use the land as a cell tower is treated as a leasehold interest and is therefore an interest in real property. A license to operate a casino as part of a hotel is not real property in Example 13 because it is a license to operate a business.

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Examples of REIT Conversions The use of REITs continues to expand to such areas as alternative energy projects, data centers, and gambling casinos. – The Proposed Regulations specifically include solar projects in the definition of real estate. – Prior to the issuance of the Proposed Regulations, at least one REIT was able to qualify as a REIT by financing solar projects with mortgage debt. – The structure provides interesting details on how a mortgage REIT can finance real estate projects secured by assets not all of which would qualify as real estate.

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Hannon Armstrong REIT On July 30, 2012, prior to the promulgation of the Proposed Regulations, Armstrong Sustainable Infrastructure Capital, Inc. (“Hannon”) received a Private Letter Ruling from the IRS with respect to its financings secured by assets qualifying under then current law as real estate assets and a mix of qualifying and non-qualifying assets where the fair market value of the qualifying assets equal or exceeded the principal amount of the loan. – Under the Proposed Regulations, a larger amount of Hannon’s equity investments in energy projects would qualify as real property. – Hannon indicated that approximately 50% of its assets would consist of energy efficient projects, 25% clean energy projects and 20-30% other sustainable projects. Nonqualifying assets, including its interest in the TRS cannot exceed 25% of the value of its total assets.

Hannon completed its public offering on April 23, 2013 as a publicly traded REIT.

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Hannon Armstrong REIT – In connection with the IPO, interests in Hannon Armstrong Capital, LLC, a limited liability company (“LLC”), taxed as a partnership , were exchanged for shares of Hannon in a tax-free transaction under Section 721 in which no gain or loss was recognized. – The Hannon Armstrong Capital, LLC became an indirect subsidiary of Hannon. – The structure is illustrated on the following slide.

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Hannon Armstrong REIT Public Stockholder s

Other Existing Stockholders

Directors and Officers

REIT Structure]]]]]11 Common Stock (82.3%)

Common Stodk (8.2%)

Hannon Armstrong Sustainable Infrastructure Capital, Inc.

Common Stodk (8.5%)

Limited Partners

(98%)

Hannon Armstrong Sustainable Infrastructure Capital, Inc.

(2%)

Taxable REIT Subsidiary

Hannon Armstrong Capital, LLC

Large Institutional Investors, primarily Insurance companies and commercial banks

Notes

Various Project Owning Special Purpose Entities (LLCs)

Hannon Armstrong Securities LLC (Broker Dealer)

Origination Companies (LLCs)

Hannon Armstrong Multi-Asset Intrastructure Trust

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Hannon Armstrong REIT Hannon describes its business model as making debt and equity investments in sustainable infrastructure projects. Those include energy efficiency and “clean energy” financing arrangements. Its basic model for energy efficiency projects is making loans to energy service companies (“ESCO”s) which make energy efficient improvements for governments, universities, hospitals, etc. which are secured by the improvements and payments for these improvements. – The ESCO typically obtains all the necessary approvals and financing for these improvements. – It would appear that most loans are secured by energy efficient assets or a mixture of renewable and energy efficient assets most of which would qualify under the Proposed Regulations. In addition, other types of assets include distributed generation and microgrids should also be qualifying real estate assets.

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Hannon Armstrong REIT In the case of clean energy projects, Hannon makes construction loans to the project developer, an ESCO, for a specific project which can be combined with other energy efficient projects designed to sell power to electric utilities or large users. – The loans are secured by all of the project including the power purchase contracts. – The mix of clean energy assets and qualifying real estate assets securing the construction loan would cause the loans to be treated as mortgages secured by interests in qualifying real estate. – However, as long as the fair market value of the qualifying real estate assets equals or exceeds the highest principal amount of the loan, the entire loan is treated as a mortgage secured by real estate assets. In that case both the mortgage loan and the interest thereon are – An interesting feature of the Hannon structure is its establishment of securitization trusts funded by construction and other loans made indirectly by the REIT.

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Windstream Spin-Off Windstream Holdings Inc. obtained 2 Private Letter Rulings from the IRS with respect to the spin-off and the qualification of the REIT. On March 5, 2014, the IRS issued PLR 2014 23010, in which it confirmed that the spinoff of a controlled corporation which makes a REIT election (the “REIT”) will qualify as a tax-free reorganization under Section 368(a)(1)(D) in which no gain or loss to Windstream, its shareholders, or the REIT will recognize gain or loss. – A REIT is a corporation for Federal income tax purposes so that the distribution of its shares to shareholders on a tax-free basis must qualify as a reorganization under Section 355. – The IRS did not rule on the business purpose, the device test or the anti-Morris Trust requirements of Section 355(e).

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Windstream Spin-Off

– Spin-offs by C corporations of their subsidiaries which then make a REIT election raise active trade or business and business purpose issues under Section 355. – A REIT is required to generate passive not active income but Section 355 requires that both the distributing parent corporation and the REIT are each engaged in an active trade business after the spi-off. Revenue Ruling 2001-29, 2001-1 CB 1348 held that a REIT can satisfy the active trade or business test of Section 355(b) by engaging in service, management and operational activities which would qualify as customary services. – The Federal income tax benefit of a REIT election does not count as a corporate business purpose which is required for Section 355. Thus, bona fide business purposes must exist apart from tax savings.

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Windstream Spin-Off – Windstream obtained an opinion of counsel that the active trade or business and business purpose requirements were met so that the spin-off was tax-free. – Notably, Windstream represented that a decision to make a REIT election by the spunoff corporation would not be made until after the spin-off, based on applicable business and market considerations at such time.

To satisfy the active trade or business requirements of Section 355(b)(1) both Windstream and Distributed were required to treat all members of their separate affiliated group as one corporation. – Thus, the activities of the TRSs held by the REIT after the election were taken into account in determining whether the active trade or business requirement of Section 355(b)(1) was satisfied. – This representation was required because the triple net lease arrangement would not have satisfied the active trade or business requirement at the REIT level.

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Windstream REIT Qualification On February 20, 2014, the IRS issued PLR 2014 23011 with respect to the qualification of the corporate subsidiary spun-off by Windstream in a taxfree transaction as a REIT. The PLR was issued prior to the promulgation of the Proposed Treasury Regulations Section 1.856-10 in May, 2014, but follows the guidance in the Proposed Regulations.

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Data Cener PLRs – Qualifying Real Property The PLR describes a “meet-me room” cross connection arrangement which is established by wires, cables and other transmission equipment. The tenants have multiple cross-connections to create a diversity in carriers, increase bandwidth and enhance reliability of telecommunication services. The premise of the PLR is that the cross-connection equipment qualifies as a structural component of the building, although most of the PLR analyzes whether the services rendered by the REIT will adversely affect the treatment of the rent received from the tenants of the centers. – Tenants access Carriers in the meet-me-room by establishing a cross-connection via wires, cables and other transmission equipment that connect ports on the Carriers’ switches and routers to the ports within tenant spaces. Tenants may have multiple cross-connections to create diversity in Carriers, increase bandwidth and enhance the reliability of telecommunications services. If a tenant requests a cross-connection, a cable is run from that tenant’s port or ports to a “meet-me-room” or demarcation area. Participating Carriers place their equipment in the meet-me-room or demarcation area that will cross-connect with the tenant’s equipment. Taxpayer Group’s platform will be Carrier neutral; this is, multiple Carriers may gain access to the Centers to provide tenants with telecommunications services and each of these Carriers pays Taxpayer Group for use of this space. 31 real challenges. real answers. sm

Data Cener PLRs – Qualifying Real Property – No tenants, including the Carriers, have access to the meet-me-room or demarcation area without Taxpayer Group’s prior approval and/or supervision by a Taxpayer Group employee. The Carriers may, however, have electronic equipment in the meet-me-room to accommodate cross-connections to tenant equipment. While each Center provides connectivity for the Carriers to exchange information with each tenant, as well as connectivity between and among tenants, it is the responsibility of each tenant to independently, and at its sole cost and expense, arrange for the receipt of telecommunications services within its space. –

The PLR discusses whether Cross-Connect Services and Remote Hands Services constitute customarily furnished service payments for which can be treated as charges customarily furnished or rendered in connection with real property which qualify as rents from real property under Section 856(d)(1).

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Services as Qualifying Income Under Section 856(d)(1)(B), rents from real property include “charges for services customarily furnished or rendered in connection with real property.” –

Services rendered to tenants of a particular building will be customary if, in the geographic market in which the building is located, tenants in buildings of a similar class are customarily furnished such services. In addition, the services cannot be rendered primarily for the convenience of the tenants. Treasury Regulations Section 1.856-4(b)(1).

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Services not meeting the customarily furnished requirement can be furnished through a taxable REIT subsidiary (“TRS”) or in some cases by an independent contractor.

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PLR 201423011 The PLR approves both Cross-Connect Services and Remote Hands Services as customary services qualifying as rents from real property. The Remote Hands Services do not include “logical access” to the equipment of the tenants, but such services may be furnished either by independent contractors or by a TRS. The Cross-Connect Services include the following: –

internet access bandwidth for tenants that do not wish to engage a carrier separately in connection with their lease of space at the center (i.e. taxpayer purchases bandwidth from a carrier and provides it to a tenant).

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interconnection at a center using wires, cables and other transmission equipment to provide tenants connectivity to carriers.

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PLR 201423011 ─

interconnection at a center using wires, cables and other transmission equipment to provide tenants direct connectivity with other tenants.

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interconnection between multiple centers, and between centers and properties owned by third parties via networks owned by carriers or taxpayer group to provide tenants connectivity to their own servers and other tenants’ servers.

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installation of the cross-connections described above (e.g., plugging in a cable that runs between the equipment of one of taxpayer group’s tenants and a carrier, or between two different tenants).

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Services As Qualifying Income The Remote Hands Services include supervision of tenants’ contractors while they work on the tenants’ equipment, and other services that do not require logical access (i.e., tenant log-in access and information) to the tenants’ equipment, such as re-sealing, relabeling or replacing external cables, rebooting servers and changing backup tapes. – Any services that require logical access to the tenants’ equipment will be provided by third-party providers that qualify as independent contractors or a TRS. – The qualified services in the PLR did not include repairs, or replacing or operating the equipment of the tenants. The qualified services did not include “Smart Hands Services” which include technical and content support for the information technology and telecommunications equipment.

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Bundling of Rent and Service Income and Foreign Corporations The fact that the REIT collects in one payment both rent for the use of space as well as amounts owed by the tenants to the TRS will not cause the REIT to be deemed to receive impermissible tenant services citing Rev. Rul. 2002-38, 2002-2 CB 4. The REIT represented that the amounts charged by the TRS for services were arm’s length charges. The REIT will own a number of foreign corporations which will be classified as controlled foreign corporations (“CFCs”) and the REIT may be required to include Subpart F income of such CFCs. – Similarly, the REIT may have income from a PFIC which has made a QEF election. – Finally, the REIT may have deemed income under Section 956 from the pledge of CFC stock or assets. – The PLR held in all of those instances that such income will constitute qualifying income under Section 856(c)(5)(J)(ii). 37 real challenges. real answers. sm

Equinix Conversion Equinix, Inc. announced in December 23, 2014, that its Board of Directors unanimously approved its conversion to a REIT for its taxable year beginning July 1, 2015. – Equinix has applied for a PLR but has not yet received it. Based on existing precedent, opinions of counsel, and that many other data centers currently operate on REITs, Equinix believes it will qualify as a REIT and will receive a favorable ruling to that effect. – Upon its conversion, Equinix will be required to “purge” itself of all of its C corporation earnings and profits by declaring a dividend. – It is notable that Equinix did not wait for the PLR to be issued. – Under recently Proposed Treasury Regulations Section 1.856-10, Equinix should be able to qualify as a REIT because of the explicit approval of data centers. – The PLR granted to Windstream would also indicate that Equinix should be able to qualify as a REIT.

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Services Provided by Equinix All of the services referred to as Cross Connect Services and Remote Hands Services provided by Equinix should qualify as “rents from real property.” The customer support lines described as ‘Smart Hands,” “Equinix Response Center” probably would not qualify as services which can be furnished directly by the REIT, but must be furnished by a TRS or by an independent contractor. Sales and marketing services would not qualify as rents from real property and must be performed by a TRS.

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Equinix Subpart F and PFIC Income Any Subpart F income or PFIC income derived by the REIT from its foreign subsidiaries will constitute qualifying income by reason of Section 856(c)(5)(j)(ii). The REIT’s income which is Subpart F or PFIC income should be qualifying income under the 95% test, but not as rents from real property under Section 856(c)(3) and the 75% test. Thus, Subpart F and PFIC income must be limited to 25% of the gross income of the Equinix REIT.

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YieldCo Structure The YieldCo structure refers to a transaction in which a corporate owner, often a utility, owns conventional and renewable energy assets, contributes those assets to a new corporation (“YieldCo”) and then distributes and or sells shares of YieldCo to its shareholders and the public. – The YieldCo intends to pay a consistent and growing dividend from its cash available for distribution. Thus, the YieldCo will be a bond like vehicle which converts the cash flow from its diverse projects into dividend income or a return of capital. – The YieldCo structure also can provide tax results similar to those of REITs and MLPs since most YieldCo’s are not expected to pay a significant amount of corporate income tax. – The YieldCo structure achieves all of its goals of a securitization for both owners of solar energy projects and investors by reducing risk, raising capital in a tax efficient manner, providing a steady increasing stream of dividend income, and a liquid market based investment. – A number of utilities have indicated an intent to issue shares of a YieldCo. On February 18, 2014, SunEdison Inc. submitted a confidential S-1 draft registration statement to the SEC for the issuance of common stock of a YieldCo vehicle. Abengoa, a Spanish entity, has indicated it plans to submit a similar confidential draft for an offering of shares of a so-called yield company. 41 real challenges. real answers. sm

Penn National Gaming (“PNG”) On September 28, 2012, IRS issued PLR 201337007 to PNG which held that the spin-off of its controlled subsidiary which elected REIT status (GLPI) was a tax-free transaction under Section 368(a)(i)(D) and Section 355. – The PLR also concluded that each of the casino properties held by GLPI qualified as real property and as a real estate asset for purposes of Section 856(c). – The REIT will lease the properties back to PNG under a triple-net lease with rent provisions tied to the “Net Revenues” of PNG. – Since the Carlino family owned more than 14% of PNG, their shareholdings were reduced prior to the spin-off to less than 10% so that the rents received by the REIT would qualify as rental income not derived from a related person under Section 856(d)(2)(B). – The active business requirements of the REIT was satisfied through the activities of its TRSs. – The REIT was permitted to declare a purge dividend in stock and cash with the stock portion not to exceed 80% of the fair market value of the distribution. 42 real challenges. real answers. sm

NYLD Structure On July 16, 2013, NRG Yield Inc. (“NRG Yield”) made an initial public offering of its Class A common stock. NRG Yield was formed by NRG Energy Inc. (“NRG”). The NRG Yield Class A common stock is listed on the New York Stock Exchange under the symbol (“NYLD”). – The NYLD structure offers a good example of how a securitization can combine 21 energy properties consisting of both conventional and renewable and thermal generation assets across 9 states thereby providing diversification and growing dividend income to investors. – Depreciation deductions and investment tax credits attributable to the new renewable energy projects can be used to offset income from older conventional projects.

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NYLD Structure – A substantial portion of the distributions should constitute a tax-free return of capital since NYLD does not expect to generate a substantial amount of earnings and profits for the foreseeable future. – Any distributions by NYLD which are treated as dividends should be eligible for the favorable 20% Federal income tax rate in the case of individuals and qualify for the dividends received deduction in the case of corporations. – The NYLD structure is tax efficient for NRG Energy and the Class A shareholders since all of the projects are owned by limited liability companies, classified as partnerships for Federal income tax purposes, which permits NRG Energy and NYLD to realize the income of the projects directly as if they were filing consolidated returns. – By using a partnership structure to hold the operating assets through a disregarded entity, NYLD would permit contributions by additional partners to monetize its investment without triggering a tax event.

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NYLD Structure – The structure permits the depreciation deductions and investment tax credits of newer projects to reduce income of other projects. NYLD stated that it does not expect to pay any significant amount of Federal income tax for 10 years. – The NYLD structure is illustrated on the following slide.

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NYLD Structure NRG Energy, Inc. (“NRG”) NYSE: NRG

Public Stockholders

Class B Common Stock 70% Voting Interest 0% Economic Unit 100% Class B Units 70% Economic Interest

NRG Yield, Inc. (“Yield Inc.”) Ticker: NYLD

Class A Common Stock 30% Voting Interest

Sole Managing Member 100% Class A Units 30% Economic Interest

NRG Yield LLC

100%

NRG Yield Operating LLC

Disregarded Entity

100%

49.9%

Other Utility Scale Solar Projects and Distributed Solar Projects

100%

Other Utility Scale Solar Projects and Distributed Solar Projects

49.95 % Other Utility Scale Solar Projects and Distributed Solar Projects

48.95 % Other Utility Scale Solar Projects and Distributed Solar Projects

100%

Other Utility Scale Solar Projects and Distributed Solar Projects

100%

Other Utility Scale Solar Projects and Distributed Solar Projects

100%

Other Utility Scale Solar Projects and Distributed Solar Projects

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NYLD Structure – Note that the conversion by NRG of its Class B Units in NRG Yield LLC into Class A Shares of NYLD would be a taxable event for NRG but NRG is expected to have net operating losses (“NOLSs”) carry forwards from its ownership of its Class B Units in NRG Yield LLC to offset such income.

The NYLD structure is in effect an UPREIT structure since NRG Energy retains its interest in the projects through its Class B Units in NRG Yield LLC which is a partnership with NRG Yield as the other partner. The Class B Units NRG Energy owns in NRG Yield LLC are exchangeable into Class A common stock of NRG Yield Inc. This is similar to investors in an UPREIT structure which can exchange their operating partnership units with stock of the REIT. This structure would also permit other equity investors to invest in NRG Yield Operating LLC to avoid corporate level taxation and contribute other assets on a tax-free basis.

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MLPs Under Section 7704 of the Code, a publicly traded partnership will be taxable as a corporation unless 90% of the gross income of the MLP consists of qualifying income. – Under Section 7704(c)(3), Section 7704 will not apply to MLPs which could qualify as REITs if they were taxed as a domestic C corporation. – Even if an MLP would not qualify as a REIT, qualifying income includes real property rents, interest, dividends and gains from the sale of real property including inventory. – MLPs have much less detailed asset and income requirements and do not contain the prohibited transaction rules on the sale of assets, – The main disadvantage of MLPs is that they are still partnerships requiring partners to file returns and they can generate UBTI and UDFI.

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