Fwd: Alert: FIRPTA and REIT Reform Provisions in the New Tax Law Open Door to Increased Foreign Investment in U.S. Real Property Interests
[{"sender": "Richard Kahn", "recipients": ["Jeffrey Epstein [jeevacation@gmail.com]"], "timestamp": "12/24/2015 12:52:15 AM", "subject": "Fwd: Alert: FIRPTA and REIT Reform Provisions in the New Tax Law Open Door to Increased Foreign Investment in U.S. Real Property Interests", "body": "Begin forwarded message:"}, {"sender": "Sadis & Goldberg Tax Group", "recipients": [], "timestamp": "December 23, 2015 at 3:02:13 PM EST", "subject": "Alert: FIRPTA and REIT Reform Provisions in the New Tax Law Open Door to Increased Foreign Investment in U.S. Real Property Interests", "body": "TAX ALERT\nDECEMBER 23, 2015\nFIRPTA and REIT Reform Provisions in\nNew Tax Law Open Door to Increased\nForeign Investment in U.S. Real\nProperty Interests\n\nOn December 18, 2015, President Obama signed into law a bill that significantly reforms the provisions\nof the Internal Revenue Code that were originally added 35 years ago by the Foreign Investment in\nReal Property Tax Act of 1980 (FIRPTA). The Protecting Americans from Tax Hikes Act of 2015 (the\n\"PATH Act\") also includes extensions of a number of tax relief provisions that expired at the end of\n2015. The PATH Act makes foreign capital investment in U.S. real estate, energy and infrastructure\nassets more attractive by expanding certain exemptions from FIRPTA and clarifying the application of\ncertain FIRPTA provisions to REITs and their shareholders.\n\nI. FOREIGN PENSION FUNDS EXEMPTED FROM FIRPTA TAXATION\nOne of the most significant provisions of the PATH Act is the addition of a complete exemption from\nFIRPTA for \"qualified foreign pension funds\" and \"entities\" wholly owned by such funds, effective on\nthe date of enactment. A foreign pension fund is \"qualified\" if it is subject to government regulation\nand certain reporting requirements in its home jurisdiction, is established to provide retirement or\npension benefits to participants or beneficiaries that are current or former employees, has no greater\nthan 5 percent beneficiaries, and enjoys tax benefits on either contributions or investment income in\nits home jurisdiction. The new exemption applies to direct investments and investments made\nthrough partnerships (including private equity funds). The PATH Act provides for certain details to be\naddressed by Treasury Regulations. It appears that the \"entities\" eligible for the FIRPTA exemption\ncould include a U.S. or foreign \"blocker\" corporation that is wholly owned by a qualifying foreign\npension fund. This exemption will, for the first time, permit foreign pension funds, including some\ngovernmental funds, to hold control positions in REITs without losing their FIRPTA exemption.\nNote that the regular rules of the Internal Revenue Code other than FIRPTA still would apply to the\nforeign pension fund. Therefore, a foreign pension fund that invested in a partnership that was\nengaged in a U.S. business (real estate or non-real estate) would still be subject to U.S. federal income\ntax on its share of the partnership's \"effectively connected\" U.S. business income in the same manner\nas other non-U.S. persons making an investment in a U.S. business partnership.\nHere are some examples of what can be done in light of the changes made by the PATH Act:\n\nA. Raw Land Investment. A qualifying foreign pension fund invests in a partnership that buys raw land\nin the United States. (This could be a vacant lot, timberland, oil and gas or mineral property, or other\nproperty interests that qualify for treatment as real property for federal income tax purposes.) The\ninvestment is a capital asset, as the partnership is not engaged in business. The partnership later sells\nthe property to a developer, or the pension fund sells its partnership interest. Under prior law, the\nforeign pension fund's non-business capital gain would automatically be subject to US federal income\ntax because of FIRPTA. Under the new law, the foreign pension fund's long-term or short-term capital\ngain is exempt from U.S. income tax and FIRPTA withholding because FIRPTA does not apply.\n\nB. Equity Kicker Mortgage Loan Investment. A foreign pension fund acquires an ownership interest\nin a mortgage loan secured by U.S. real property. The loan includes stated interest plus an equity\nkicker (e.g., additional interest equal to a share of gain realized on sale of the property). Such an\nequity kicker loan is treated as a U.S. real property interest under FIRPTA. Under prior law, gain\nrealized by the foreign pension fund upon sale of the loan would automatically be subject to U.S.\nincome tax under FIRPTA. Under new law, the gain realized on the sale of the mortgage loan would\nbe exempt from U.S. income tax. (This conclusion is based on the assumption that the foreign pension\nfund is a mere investor and not engaged in an active lending business in the U.S.)\n\nC. U.S. Blocker Corp. Investment. A foreign pension fund wants to make an equity investment in a\nU.S. real estate business that is organized as a partnership. The foreign pension fund forms a U.S.\ncorporation to acquire the partnership interest and the corporation is capitalized with a mix of equity\nand debt held by the shareholder. The corporation is subject to U.S. income tax on its net income, but\ngets to deduct interest paid or accrued on the debt held by the shareholder. The foreign corporation\nlater sells the stock of the corporation. Under prior law, the gain on sale of the stock would be subject\nto U.S. income tax because the corporation was a \"U.S. real property holding corporation\" under\nFIRPTA. Under new law, FIRPTA does not apply to the foreign pension fund, so the capital gain on sale\nof the stock is exempt from U.S. income tax. Note that the U.S.-source interest paid to the foreign\nshareholder could be subject to U.S. withholding tax under the regular rules of the Code, but if the\npension fund is organized in a jurisdiction that has a tax treaty with the U.S. (e.g., UK, Germany,\nFrance, China, Japan, etc.), these interest payments could be exempt from U.S. withholding under such\ntax treaty.\n\n2. FIRPTA EXEMPTION FOR INVESTMENTS IN PUBLICLY TRADED REIT STOCK INCREASED FROM 5\nPERCENT to 10 PERCENT\nFor publicly traded REITs, the PATH Act opens the door to increased investment by expanding the\ncurrent statutory exemption from FIRPTA for small portfolio investments by non-U.S. persons. The Act\nprovides all foreign investors (not just pension funds) can now own up to 10 percent of the stock of a\npublicly traded REIT without triggering FIRPTA tax. Under prior law, FIRPTA tax would apply upon the\nforeign investor's sale of stock of the publicly traded REIT or the receipt of certain distributions from\nsuch REIT if the foreign investor holds more than 5 percent of the REIT's stock.\n\n3. CLARIFICATION OF THE EXEMPTION FOR INVESTMENTS IN DOMESTICALLY CONTROLLED REITS\nThe PATH Act includes important clarifying presumptions that will allow publicly traded REITs and their\nshareholders to rely with greater confidence on the current law FIRPTA exemption for gains realized\non sales of stock in \"domestically controlled\" REITS. In determining whether a REIT is domestically\ncontrolled, the REIT is now permitted to presume that any owner of less than 5 percent of any publicly\ntraded shares of the REIT is a U.S. person, unless the REIT has actual knowledge to the contrary.\n\n4. REVENUE RAISING PROVISIONS RELATING TO FIRPTA AND REITs\nThe PATH Act includes certain revenue raising provisions to offset, in part, the tax revenue loss\nanticipated to result of the above-described tax reform provisions of the Act. Such revenue raisers\ninclude (among other technical changes) the following provisions:\n\nA. Increase in FIRPTA Withholding Rate. The purchaser of a U.S. real property interest from a non-\nU.S. person was previously required to withhold 10 percent of the purchase price under FIRPTA. The\nPATH Act increases this rate to 15 percent for dispositions occurring after the 60th day following\nenactment, but maintains the 10 percent rate for sales of residential property for between $300,000\nand $1,000,000. This provision is not a tax increase but is designed to ensure that FIRPTA withholding\ncollects a sufficient portion of the taxes owed.\n\nB. Restriction on REIT Spin-offs. In recent years, it has become increasingly common for large\ncorporate taxpayers to reduce their tax bills by contributing real estate used in their businesses to a\nsubsidiary, spinning off the subsidiary in a tax free transaction under Code section 355, and then\nhaving the spun-out corporation making a REIT election. The PATH Act curtails such activity by (i)\nproviding that neither the distributing corporation nor the spun-out corporation can make a REIT\nelection for ten years after that corporation was involved in a Section 355 transaction and (ii) denying\ntax-free treatment to spin-offs in which the distributing corporation or spun-out corporation (but not\nboth) is a REIT.\n\n5. CONCLUSION\nThe revisions to the FIRPTA and REIT rules discussed above represent a potentially large expansion of\nthe incentives for foreign investment in U.S. real property interests, especially for foreign pension\nfunds. Sponsors of U.S. real property investment funds and foreign investors with interests in U.S. real\nestate assets should review the new provisions to determine whether such persons could benefit from\nsuch U.S. tax law changes."}]