June 7 (Bloomberg) -- Iron Mountain Inc. and Equinix Inc., two technology companies planning to convert to real estate investment trusts, plunged after saying that the U.S. Internal Revenue Service is scrutinizing their eligibility.
The IRS is weighing whether to narrow the legal definition of real estate for the purposes of converting to a trust, the companies said in separate regulatory filings.
As businesses from data centers to billboard owners make the switch to REITs -- which are subject to lower taxes and pay higher dividends than other companies -- the IRS is considering whether to restrict the types of enterprises that should qualify. The review means companies with nontraditional real estate operations -- like Equinix, which runs data centers, and Iron Mountain, which rents storage space and maintains paper and electronic records -- may struggle to win approval.
“If you’re a company with traditional real estate, then I don’t think you have any trouble creating a REIT out of that,” Rich Moore, an analyst at RBC Capital Markets in Solon, Ohio, said in a telephone interview. “If you’re a company who’s got unusual or a questionable classification of real estate, like billboards for example, I think you’re going to face more scrutiny.”
Shares of Boston-based Iron Mountain fell the most since 1998, slumping 16 percent to $28.95. Equinix, based in Redwood City, California, dropped 5.5 percent to $192.57, the biggest decline since August 2011.
Lamar Advertising Co., the Baton Rouge, Louisiana-based owner of outdoor-advertising displays that also disclosed an IRS review of its REIT election, declined 4.2 percent to $43.62.
CBS Corp., owner of the most-watched U.S. television network, is planning for its outdoor-advertising business to become a REIT. CBS made its submission to the IRS for a ruling on the conversion in the first quarter, according to a conference call last month.
Dana McClintock, a spokesman for New York-based CBS, declined to comment. CBS fell 1.7 percent to $48.03.
In the case of Iron Mountain, the IRS is questioning whether its warehouses filled with stacks of servers constitute real estate, according the company’s filing with the U.S. Securities and Exchange Commission.
“Under current legal standards the company’s racking structures are ‘real estate’ for REIT purposes,” Iron Mountain said in the filing. “However, the company can provide no assurances that the IRS will agree.”
Equinix, for its part, defended its data centers as eligible for REIT status “based on both existing legal precedent and the fact that other data center companies currently operate as REITs,” according to the company’s filing.
Data center businesses already operating as REITs include Digital Realty Trust Inc. and DuPont Fabros Technology Inc. Digital Realty declined 3.2 percent, while DuPont fell 0.3 percent.
Representatives for the IRS didn’t respond to a request for comment.
Lamar said in its filing that based on discussions with the IRS, it had “no reason to conclude” that it wouldn’t be able to complete its conversion by Jan. 1 as planned. The IRS has already deemed billboards real property for purposes of a REIT, Chief Executive Officer Sean Reilly said at a conference in September.
To qualify as a REIT, a company has to invest at least 75 percent of its assets in real estate and obtain 75 percent of its gross income from rents or interest on mortgages from financing property, according to the National Association of Real Estate Investment Trusts, a Washington-based trade group. REITs sell equity and debt to fuel growth, and must return at least 90 percent of their taxable earnings to shareholders in the form of dividends.
Two prison operators -- Corrections Corp. of America and GEO Group Inc. -- began operating as REITs this year. CyrusOne Inc., a Carrollton, Texas-based data-center company that was spun out of Cincinnati Bell Inc., will qualify as a REIT this tax year, according to a regulatory filing.
At best, the IRS review of REIT eligibility will delay some approvals, and at worst, it may “put some conversions in danger,” Omotayo Okusanya, an analyst at Jefferies Group LLC, wrote in a research note.
“This news is a net negative for REIT conversion hopefuls,” Okusanya said.