No, it does not automatically turn into the unspaced version.
Here is what happens. A while back there was glitch in the gamertag creation system, in which it actually counted spaces as characters in gamertags. So basically, if someobyd owned "Kill", you coulc take K ill and it would be available. Now, since they have patched that glitch, the only spaced out OGs are the ones left. So, because spaces do not count as characters anymore, you cannot take the tag Po op if somebody owns Poop.
Because of that patch, when a gamertag gets reset for being unused for a ong period of time, if somebody owns a spaced version of that tag, they can pay 800 MSP and change their tag to that tag, but nobody else can because their spaced tag technically saves the spot for the reset.