COPT Defense Properties Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes

Income Taxes

12 Months Ended

Dec. 31, 2014

COPT elected to be treated as a REIT under Sections 856 through 860 of the Internal Revenue Code. To qualify as a REIT, COPT must meet a number of organizational and operational requirements, including a requirement that it distribute at least 90% of the Company’s adjusted taxable income to its shareholders. As a REIT, COPT generally will not be subject to Federal income tax on taxable income that it distributes to its shareholders. If COPT fails to qualify as a REIT in any tax year, it will be subject to Federal income tax on its taxable income at regular corporate rates and may not be able to qualify as a REIT for four subsequent tax years.

COPLP is a limited partnership and is not subject to federal income tax. Its partners are required to report their respective share of the Operating Partnership’s taxable income on their respective tax returns. COPT’s share of the Operating Partnership’s taxable income is reported on COPT’s income tax return.

The differences between taxable income reported on our income tax returns (estimated 2014 and actual 2013 and 2012) and net income as reported on our consolidated statements of operations are set forth below (in thousands):



	For the Years Ended December 31,
	2014			2013			2012
	(Estimated)
COPLP consolidated net income	$	45,206		$	101,544		$	20,341
Adjustments:
Rental revenue recognition	(3,932		)	1,303			(10,794		)
Compensation expense recognition	1,912			8,987			(2,669		)
Operating expense recognition	(2,260		)	(1,663		)	1,158
Gain on sales of properties	(1,404		)	(50,860		)	(74,858		)
Impairment losses	1,367			32,047			66,910
Loss on interest rate derivatives	—			—			(29,805		)
Gains from non-real estate investments	405			—			7,854
Income from service operations	(391		)	1,650			1,500
Income tax expense	310			1,978			381
Depreciation and amortization	41,500			20,834			24,804
Interest expense	920			2,057			3,978
Income from unconsolidated entities	(187		)	3,148			(725		)
COPLP consolidated noncontrolling interests	(3,285		)	(7,837		)	(636		)
Other	2,346			1,529			(70		)
COPLP consolidated taxable income	$	82,507		$	114,717		$	7,369
Noncontrolling interests, other	(3,247		)	(4,061		)	(622		)
Other	—			—			741
COPT consolidated taxable income	$	79,260		$	110,656		$	7,488

For Federal income tax purposes, dividends to shareholders may be characterized as ordinary income, capital gains or return of capital. The characterization of dividends declared on COPT’s common and preferred shares during each of the last three years was as follows:



	Common Shares						Preferred Shares
	For the Years Ended December 31,						For the Years Ended December 31,
	2014		2013		2012		2014		2013		2012
Ordinary income	64.5	%	71.8	%	33.2	%	90.9	%	76.2	%	100.0	%
Long-term capital gain	6.5	%	22.4	%	0.0	%	9.1	%	23.8	%	0.0	%
Return of capital	29.0	%	5.8	%	66.8	%	0.0	%	0.0	%	0.0	%

We distributed all of COPT’s REIT taxable income in 2014, 2013 and 2012 and, as a result, did not incur Federal income tax in those years on such income.

The net basis of our consolidated assets and liabilities for tax reporting purposes is approximately $233 million lower than the amount reported on our consolidated balance sheet at December 31, 2014, which is primarily related to differences in basis for net properties, intangible assets on property acquisitions and deferred rent receivable.

We own a TRS that is subject to Federal and state income taxes. Our TRS had income before income taxes under GAAP of $822,000 in 2014, $330,000 in 2013 and $11.3 million in 2012. Our TRS’ provision for income tax consisted of the following expenses (in thousands):



	For the Years Ended December 31,
	2014		2013		2012
Deferred
Federal	$	258	$	1,742	$	312
State	52		236		69
Total income tax expense	$	310	$	1,978	$	381

A reconciliation of our TRS’ Federal statutory rate to the effective tax rate for income tax reported on our statements of operations is set forth below:



	For the Years Ended December 31,
	2014		2013		2012
Income taxes at U.S. statutory rate	34.0	%	34.0	%	34.0	%
State and local, net of U.S. Federal tax benefit	4.2	%	4.5	%	4.6	%
Increase in deferred tax asset valuation allowance	0.0	%	562.9	%	0.0	%
Other	(0.4	)%	(1.1	)%	0.0	%
Effective tax rate	37.8	%	600.3	%	38.6	%

Items in our TRS contributing to temporary differences that lead to deferred taxes include depreciation and amortization, share-based compensation, certain accrued compensation, compensation paid in the form of contributions to a deferred nonqualified compensation plan, impairment losses and net operating losses that are not deductible until future periods. As of December 31, 2014, our TRS had a net operating loss carryforward for federal income tax purposes of approximately $13 million expiring in 2033. We believe that our TRS is no longer subject to income tax examinations for years prior to 2011.

The table below sets forth the tax effects of temporary differences and carry forwards included in the net deferred tax asset of our TRS (in thousands):



	December 31,
	2014			2013
Operating loss forward	$	5,012		$	5,382
Share-based compensation	976			869
Accrued payroll	195			221
Property	(119		)	(105		)
Valuation allowance	(2,062		)	(2,062		)
Deferred tax asset, net	$	4,002		$	4,305

We recognize a valuation allowance on our deferred tax asset if we believe all or some portion of the deferred tax asset may not be realized. An increase or decrease in the valuation allowance resulting from a change in circumstances that causes a change in our judgment about the realizability of our deferred tax asset is included in income. In 2013, we recognized a $1.9 million increase in our deferred tax asset valuation allowance due to a decrease in future projected operating income in our TRS resulting primarily from our dispositions of certain properties to which the TRS provided amenity services and our planned reduction in amenity services provided by the TRS at certain other properties. We believe it is more likely than not that the results of future operations in our TRS will generate sufficient taxable income to realize our December 31, 2014 net deferred tax asset.

We are subject to certain state and local income and franchise taxes. The expense associated with these state and local taxes is included in general and administrative expense and property operating expenses on our consolidated statements of operations. We did not separately state these amounts on our consolidated statements of operations because they are insignificant.

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

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