Key Takeaways
- • Professor James R. Repetti of Boston College Law School argues that federal tax rules, not investment returns alone, help explain why tax-exempt institutions invest heavily in private equity funds that use leverage in hospital and nursing home acquisitions.
- • Under debt-financed income rules, a tax-exempt investor that borrows directly can owe tax on leveraged returns, but placing acquisition debt on the target company lets the investor capture leverage benefits without being treated as the borrower.
- • Repetti cites one empirical study of hospital sales finding that tax-exempt sellers demanded less than comparable taxable sellers, consistent with a 'lock-in' effect that passes part of the exemption's value to for-profit buyers.
- • Repetti notes that blocker corporations, often Cayman Islands entities, can let exempt investors participate in debt-laden funds without triggering the same rules, and proposes extending the debt-financed rules to look through blockers and target companies.
- • The article links leveraged buyouts and sale-leaseback arrangements with REITs to cost-cutting pressure on staffing and supplies, which Repetti argues can make maintaining patient care levels difficult.
Summary
Boston College Law School professor James R. Repetti, the William J. Kenealy, SJ, Professor of Law, examines in his article "Private Equity, Health Calamity: How Our Tax Laws Aid Private Equity Investment in Hospitals and Nursing Homes" how federal tax rules encourage private equity investment in hospitals and nursing homes. According to the piece, nonprofit hospitals and nursing homes generally pay no income tax on gains when they sell facilities to for-profit purchasers, while university endowments, pension funds, foundations and other tax-exempt investors can invest in leveraged private equity funds without triggering the tax that would apply if they borrowed directly.
Repetti told the magazine that over roughly the past five years private equity returns had not kept pace with the S&P 500, which led him to question why tax-exempt institutions invested so heavily in these funds. In a leveraged buyout, the acquisition debt is placed on the target company, so the tax-exempt investor receives the economic benefit of leverage while the debt is treated as the target's rather than its own. Repetti argues that this structure can make cost cutting a necessary part of the business plan, affecting staffing, equipment and supplies. He also highlights hospital real estate sales to real estate investment trusts followed by leasebacks, which add rent obligations that the hospital must meet alongside other expenses.
Repetti cites studies reporting harmful or mixed outcomes after private equity acquisitions, including one finding an 11 percent greater probability of death during and shortly after stays in private equity-owned nursing homes. He recounts the case of St. Elizabeth's Medical Center in Brighton, Massachusetts, part of the private equity-owned Steward Health Care, where a delivery procedure was complicated when an instrument had been repossessed by the hospital's creditors.
On the seller side, Repetti explains that a tax-exempt hospital builds going-concern value while exempt, and that a sale to a for-profit buyer may be an appropriate point for government to recapture tax benefits. He cautions that only one empirical study has examined hospital sales specifically; it found evidence consistent with tax-exempt sellers accepting lower prices than comparable taxable sellers, which he describes as a 'lock-in' effect.
Repetti also describes blocker corporations, often Cayman Islands entities, which shield exempt investors from debt-financed income rules because the current rules do not look through them. He argues that if policymakers treat the problem as real, the rules must address these routes, and he favors extending the debt-financed rules to look through blockers and target companies to the debt actually financing acquisitions.
Repetti told the magazine that over roughly the past five years private equity returns had not kept pace with the S&P 500, which led him to question why tax-exempt institutions invested so heavily in these funds. In a leveraged buyout, the acquisition debt is placed on the target company, so the tax-exempt investor receives the economic benefit of leverage while the debt is treated as the target's rather than its own. Repetti argues that this structure can make cost cutting a necessary part of the business plan, affecting staffing, equipment and supplies. He also highlights hospital real estate sales to real estate investment trusts followed by leasebacks, which add rent obligations that the hospital must meet alongside other expenses.
Repetti cites studies reporting harmful or mixed outcomes after private equity acquisitions, including one finding an 11 percent greater probability of death during and shortly after stays in private equity-owned nursing homes. He recounts the case of St. Elizabeth's Medical Center in Brighton, Massachusetts, part of the private equity-owned Steward Health Care, where a delivery procedure was complicated when an instrument had been repossessed by the hospital's creditors.
On the seller side, Repetti explains that a tax-exempt hospital builds going-concern value while exempt, and that a sale to a for-profit buyer may be an appropriate point for government to recapture tax benefits. He cautions that only one empirical study has examined hospital sales specifically; it found evidence consistent with tax-exempt sellers accepting lower prices than comparable taxable sellers, which he describes as a 'lock-in' effect.
Repetti also describes blocker corporations, often Cayman Islands entities, which shield exempt investors from debt-financed income rules because the current rules do not look through them. He argues that if policymakers treat the problem as real, the rules must address these routes, and he favors extending the debt-financed rules to look through blockers and target companies to the debt actually financing acquisitions.
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