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Proposed FIRPTA Reforms Could Be Good News for US Real Estate
Practical Law Legal Update 6-601-6346 (Approx. 5 pages)
Proposed FIRPTA Reforms Could Be Good News for US Real Estate
by Practical Law Real Estate
| Published on 09 Mar 2015 • USA (National/Federal) |
The Senate Finance Committee passed a bill to amend the Foreign Investment in Real Property Tax Act (FIRPTA) with the aim of generating greater foreign investment in the US real estate market.
On February 12, 2015, the Senate Finance Committee unanimously approved a bill that offers significant reform to the Foreign Investment in Real Property Tax Act (FIRPTA) and seeks to encourage further foreign investment in US real estate. FIRPTA was enacted by Congress in 1980 as a means to tax income earned by non-US persons (nonresident alien individuals and non-US corporations) from the sale of US real property.
The proposed bill is part of an ongoing initiative to encourage foreign investment into the US real estate market by reducing the deterrents created by FIRPTA. The proposals represent the most significant changes to FIRPTA since it was enacted, but proponents of the bill acknowledge that it only addresses one element of FIRPTA reform. Future amendments containing more comprehensive reforms will likely be proposed to provide relief for foreign investors, such as foreign pension plans wanting to invest in the US.
Proposed FIRPTA Reforms
Maximum Foreign Shareholder Stock Ownership in REITs Increased from 5% to 10%
If passed, the proposed reforms bring good news for publicly traded real estate investment trusts (REITs) hoping to increase foreign investment in US real property. Currently, under the definition of US real property interest (USRPI) a foreign investor owning more than 5% of a publicly traded REIT is subject to FIRPTA taxation upon:
- A sale of REIT stock.
- Receipt of a distribution from the REIT that is attributable to gain from the sale or exchange of USRPIs.
As a practical matter, this rule limits foreign investment. However, raising the FIRPTA exemption available to foreign "portfolio investors" from 5% to 10% would potentially increase foreign investment in publicly traded REITs.
The proposal would also add a new exception from the FIRPTA rules for stock held in a REIT by certain "qualified shareholders," which are "qualified collective investment vehicles" that are eligible for the benefit of a comprehensive income tax treaty with the US and meet certain reporting and other requirements. This exception, however, may be quite limited. Stock of a REIT held by a qualified shareholder would not be considered a USRPI unless an investor in the qualified shareholder owns directly or indirectly more than 10% of the REIT stock.
Domestically Controlled Exception
The proposed bill also includes certain clarifications that would allow a publicly traded REIT to rely on the domestically controlled exception to the FIRTPA tax.
Currently, any gain resulting from the sale or disposition of stock of a "domestically controlled" REIT is exempt from FIRPTA taxation. Under the existing guidelines, a REIT is considered domestically controlled when 50% or more of its stock is held by US persons. However, many publicly traded REITs have not taken advantage of this exception because they are often unable to determine the domestic or foreign status of their small shareholders (those holding less than a 5% interest) and do not want to risk noncompliance.
The new bill provides that:
- A REIT regularly traded on an established US securities market may presume that all shareholders holding less than a 5% interest are US persons, unless the REIT has actual knowledge otherwise.
- Stock in a REIT held by an upper-tier entity that is either a publicly traded REIT or a regulated investment company (RIC) will be treated as held by a foreign person unless the upper-tier entity itself is domestically controlled.
- REIT stock held by any other type of upper-tier REIT or RIC will be treated as domestically controlled only to the extent the stock of the upper-tier entity is held by a US person.
These reforms should provide greater certainty to foreign investors wishing to take advantage of the "domestically controlled" exception to FIRPTA taxation by clarifying the domestic status of an investment in both public and private US REITs.
New Proposals
The bill also contains several proposed additions to the FIRPTA tax regime, although these proposals generally do not impose any new tax under FIRPTA.
FIRPTA Withholding Tax Rate
The bill would increase the FIRPTA withholding rate from 10% to 15% on the disposition or distribution of a US real property interest. This higher rate would not apply, however, to the sale of residences intended for personal use if the amount realized is $1 million or less.
Disclosure Requirements
The bill would require a US corporation that is a real property holding company (USRPHC), or any corporation that was a real property holding company in the 5 years prior to the disclosure date, to publicly disclose its FIRPTA status to shareholders and the IRS. In the absence of such a disclosure, a REIT or RIC that is a USRPHC would be presumed to be foreign controlled.
FIRPTA Withholding by Brokers
The bill would require certain brokers to deduct and withhold a tax equal to 15% of the amount realized on a disposition of stock of a USRPHC.
Brokers would be exempt from withholding:
- On dispositions of any class of stock of a USRPHC that is regularly traded on an established securities market if immediately prior to the disposition the transferor holds 5% or less of such stock (or 10% or less of REIT stock).
- If the broker has no actual or constructive knowledge that the disposition was stock of a USRPHC.
This proposal would only apply to dispositions after December 15, 2015.
FIRPTA Cleansing Rule
The FIRPTA cleansing rule currently provides that a USRPI does not include an interest in a corporation that:
- On the date of disposition of an interest in the corporation does not hold any USRPIs.
- Disposed of all of its USRPI in one or more taxable transactions.
Under the proposal, the cleansing rule will not apply to:
- REITs.
- RICs.
- A corporation, if the corporation (or a predecessor) was a REIT or RIC at any time during the shorter of the shareholder’s ownership period or the five years prior to the disposition.
For additional information about FIRPTA tax and withholding, see Practice Note, Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules.