Drive Shack Inc. 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, 2017

The provision for income taxes consists of the following:



	Year Ended December 31,
	2017		2016		2015
Current:
Federal	$	710	$	28	$	298
State and Local	255		64		101
Total Current Provision	$	965	$	92	$	399

Deferred
Federal	$	—	$	83	$	(46	)
State and Local	—		14		(8		)
Total Deferred Provision	$	—	$	97	$	(54	)

Total Provision for Income Taxes	$	965	$	189	$	345

On February 23, 2017, the Company revoked its election to be treated as a REIT effective January 1, 2017. The Company operated in a manner intended to qualify as a REIT for federal income tax purposes through the tax year ending December 31, 2016.

During 2010 and 2009, the Company repurchased an aggregate of $787.8 million face amount of its outstanding CDO debt and junior subordinated notes at a discount and recorded $521.1 million of aggregate gain. The gain recorded upon such cancellation of indebtedness is characterized as ordinary income for tax purposes. In compliance with current tax laws, the Company has the ability to defer such ordinary income to future years and has deferred all or a portion of such gain for 2010 and 2009. However, cancellation of indebtedness income recognized on or after January 1, 2011 cannot be deferred and must generally be recognized as ordinary income in the year of such cancellation. During 2011, the Company repurchased $188.9 million face amount of its outstanding CDO debt and notes payable at a discount and recorded $81.1 million of gain for tax purposes, of which only $66.1 million gain relating to $171.8 million face amount of debt repurchased was recognized for GAAP purposes. During 2012, the Company repurchased $39.3 million face amount of the Company's CDO debt and notes payable at a discount and recorded a $24.1 million gain on extinguishment of debt for GAAP, of which only $23.2 million of gain relating to $34.1 million face amount of debt repurchased was recognized for tax purposes. During 2013, Drive Shack Inc. repurchased $35.9 million face amount of the Company's CDO debt and notes payable at a discount and recorded a $4.6 million gain on extinguishment of debt for GAAP and tax purposes. During 2014, the Company did not repurchase any of the outstanding CDO debt and notes payable. During 2015, the Company repurchased $11.5 million face amount of the Company's CDO debt and notes payable at a discount and recorded a $0.5 million gain on extinguishment of debt for GAAP and tax purposes.

In addition, the Company may recognize material ordinary income from the cancellation of debt within its non-recourse financing, and structures, including its subprime securitizations, while losses on the related collateral may be recognized as capital losses. Through December 31, 2017, $173.2 million of debt in the Company’s subprime securitizations has been cancelled as a result of losses incurred on the underlying assets in the securitization trusts.

As of December 31, 2016, the Company had a net operating loss carryforward of approximately $443.7 million. The net operating loss carryforward can generally be used to offset future taxable income for up to 20 years. The amount of net operating loss carryforward as of December 31, 2017 is subject to the finalization of the 2017 tax returns. The net operating loss carryforward will begin to expire in 2023.

As of December 31, 2017, the Company has a capital loss carryforward of approximately $23.1 million. The capital loss carryforward can generally be used to offset capital gains for up to 5 years. The net capital loss carryforward will begin to expire in 2022.

The Company experienced an “ownership change” for purposes of Section 382 of the Code in January 2013. The provisions of Section 382 of the Code will impose an annual limit on the amount of net operating loss and net capital loss carryforwards that the Company can use to offset future taxable income.

The Company and its subsidiaries file income tax returns with the U.S. federal government and various state and local jurisdictions. Generally, the Company is no longer subject to tax examinations by tax authorities for years prior to 2014. The Company has assessed its tax positions for all open years and concluded that there are no material uncertainties to be recognized. The Company does not believe that it is reasonably possible that the total amount of unrecognized tax benefits will significantly change within the next twelve months.

The 2014 federal income tax return for one of the Company’s subsidiaries is currently under examination. At this time, the Company cannot estimate when the examination will conclude or the impact such examination will have on its Consolidated Financial Statements, if any.

The Company is subject to significant tax risks. In light of the revocation of its REIT election, the Company is subject to U.S. federal corporate income tax (including any applicable alternative minimum tax), which could be material.

Generally, the Company’s effective tax rate differs from the federal statutory rate as a result of state and local taxes and changes in the valuation allowance.

The difference between the Company's reported provision for income taxes and the U.S. federal statutory rate of 35% is as follows:



	December 31,
	2017		2016		2015
Provision at the statutory rate	35.00	%	35.00	%	35.00	%
Non-taxable REIT income	—	%	(51.97	)%	(86.91	)%
Permanent items	(0.36	)%	0.23	%	31.24	%
State and local taxes	(0.42	)%	0.07	%	0.32	%
Valuation allowance	64.46	%	15.56	%	22.04	%
Effects of change in tax rate	(101.31	)%	—	%	—	%
Other	0.31	%	1.35	%	(0.04	)%
Total provision (benefit)	(2.32	)%	0.24	%	1.65	%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets as of December 31, 2017 and 2016 are presented below:



	December 31,
	2017			2016
Deferred tax assets:
Allowance for loan losses	$	242		$	358
Depreciation and amortization	26,038			38,598
Accrued expenses	1,936			2,885
Interest	4,538			16,503
Net operating losses	100,297			162,629
Capital losses	6,070			—
Deferred revenue	2,295			—
Other	2,225			2,036
Total deferred tax assets	143,641			223,009
Less valuation allowance	(106,466		)	(133,192		)
Net deferred tax assets	$	37,175		$	89,817
Deferred tax liabilities:
Leaseholds	8,568			13,681
Cancellation of debt	23,385			75,632
Membership deposit liabilities	5,222			—
Other	—			504
Total deferred tax liabilities	$	37,175		$	89,817
Net deferred tax assets	$	—		$	—

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible.

The Company recorded a valuation allowance against its deferred tax assets as of December 31, 2017 as management does not believe that it is more likely than not that the deferred tax assets will be realized.

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law. The Tax Act significantly revises the U.S. corporate income tax regime by, among other things, lowering corporate income tax rates and eliminating the alternative minimum tax (“AMT”) for corporate taxpayers. The Company has accounted for the effects of the Tax Act for the year ended December 31, 2017 which relates to the re-measure of deferred tax assets and liabilities due to the reduction in the corporate income tax rate and has booked a non-recurring income tax receivable in the amount of $0.6 million due to refundable AMT credits. Due to the full valuation allowance, the re-measure of deferred tax assets and liabilities had no impact on the income tax provision for the year ended December 31, 2017.

The following table summarizes the change in the deferred tax asset valuation allowance:



Valuation allowance at December 31, 2016	$	133,192
Increase due to current year operations	15,295
Decrease due to tax rate change	(42,021		)
Valuation allowance at December 31, 2017	$	106,466