Real Estate Tax Alert FIRPTA reform passes Senate Finance Committee

Real Estate Tax Alert
FIRPTA reform passes Senate Finance Committee
The Senate Finance Committee recently passed certain changes to the Foreign Investment in Real Property Tax
Act (FIRPTA) which generally subjects non-US persons to tax on sales of United States real property interests.
The bill was passed unanimously, evidencing bipartisan support. While this is an important step in the legislative
process, the bill would need to be passed by both Houses of Congress and signed into law by the president before
it became effective.
Increased investment opportunities for non-US investors in publicly
traded REITs
If the bill were to become law, one beneficiary would be publicly traded REITs as it would allow them to more
easily attract foreign capital.
Under current law, FIRPTA can cause non-US investors to be subject to US taxes with respect to certain sales of
REIT stock and certain distributions from REITs. Often the FIRPTA taxes can be more than the taxes that would
be owed if the foreign investor had invested in other publicly traded non-real estate companies. In addition, if a
foreign investor is subject to FIRPTA, generally the foreign investor would be required to file a US federal
income tax return.
An exemption from FIRPTA currently applies with respect to investments in publicly traded companies if the
foreign investor owns 5% or less of the company’s stock. The bill would increase the limit from 5% to 10% for
publicly traded REITs.
In addition, the bill provides that interests in publicly traded REITs held by publicly traded “qualified collective
investment vehicles” would also be exempt from FIRPTA. To be eligible for the exemption, among other things,
the investor must be eligible for a reduced rate of withholding under a comprehensive income tax treaty which
includes an exchange of information program and would also be required to maintain certain information on the
identity of its owners.
New rules and presumptions for domestically controlled REIT status
The bill would provide some new rules and presumptions regarding the determination of whether a REIT is a
domestically controlled REIT.
Under current law, the sale of stock of a domestically controlled REIT is not subject to FIRPTA. A domestically
controlled REIT generally is a REIT, less than 50% of the stock of which is held by foreign persons.
The bill provides that publicly traded REITs listed on a US exchange will be able to treat their shareholders that
hold less than 5% of their stock as US persons, except to the extent the REIT has actual knowledge that such
shareholders are non-US persons. If this bill passes, this would be welcome news for public REITs which often
believe they are domestically controlled, but are unable to confirm this due to their lack of insight regarding the
individual owners of their stock.
The bill also provides some rules related to the treatment of REITs that are shareholders in other REITs for
purposes of determining if the lower-tier REITs are domestically controlled.
First, a publicly traded REIT that itself is a domestically controlled REIT would be treated as a US person in
whole (even if it did have some foreign shareholders). Second, a publicly traded REIT that is not a domestically
controlled REIT would be treated as a non-US person in whole (even though the shareholder REIT is, itself, a US
person and even if the shareholder REIT did have some US shareholders). Finally, a non-publicly traded REIT
would be treated as a US person only to the extent that the stock of the non-publicly traded REIT was held by US
persons.
Increased enforcement of current FIRPTA tax rules
In addition, there were several offsets that were intended to raise additional revenue to pay for the items noted
above. Several of these offsets are not changes to the substantive FIRPTA tax rules, but change the rules
regarding FIRPTA withholding to increase the taxes that are actually collected by improving compliance with
FIRPTA.
First, the rate of withholding on FIRPTA generally would increase from 10% to 15%. Note that this is not an
increase in the substantive FIRPTA tax, but an increase in the withholding that would be required by a purchaser
in connection with the acquisition of real property from a non-US person. The withholding would generally
offset any tax actually due from the non-US person on the sale and would be eligible for refund to the extent the
substantive tax was less than the amount withheld.
One aspect of the bill that deserves the particular attention is a new provision that would require public
disclosure regarding whether the entity is treated as a United States real property holding corporation
(USRPHC). The proposal is interesting in that it requires disclosure not only on the entity’s tax return and Forms
1099, but in various other places such as the entity’s website, annual reports and stock certificates. The final
legislative language will need to be reviewed to determine how burdensome it may be to provide such
disclosures, where the disclosures will need to be made, and how changes in the USRPHC status of an entity
should be taken into account. A severe penalty of at least $500,000, increasing to $5 million ($10 million for an
intentional failure to report), based on the gross fair market value of the corporation’s assets, is provided for
failures to meet the disclosure requirement and should garner the attention of those tasked with tax compliance
at various companies. This penalty seems extraordinarily high for failure failing to satisfy an administrative
requirement.
In another effort to increase compliance with the current FIRPTA regime, brokers would now be required to
withhold a portion of the sales proceeds on the sale of interests in corporations, the sale of stock of which would
be subject to FIRPTA. Again, this provision does not increase the FIRPTA tax owed, but puts additional rules in
place to increase the likelihood that current taxes imposed under FIRPTA are collected.
Other revenue offsets
Under current rules, if an interest in a corporation would be subject to FIRPTA if sold, the corporation could
cleanse its FIRPTA taint if the corporation liquidates after selling all of its US real property interest in taxable
transactions. The bill would provide that any corporation that was a REIT or a RIC in the prior five years would
not be able to cleanse its FIRPTA status in this manner.
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Finally, for purposes of determining whether dividends from a foreign corporation (attributable to dividends
from an 80-percent owned domestic corporation) are eligible for a dividends-received deduction under section
245 of the Code, dividends from RICs and REITs are not treated as dividends from domestic corporations.
Other FIRPTA proposals
While several of the provisions noted above have been included in various FIRPTA reform proposals in the past,
it is worth noting some of the FIRPTA reform proposals that have been advanced were not included in the bill
discussed above.
First, there have proposals to exempt foreign pension funds from FIRPTA to put them in a similar place to US
pension funds. While this provision was not included in the bill that was passed by the Senate Finance
Committee, it was subject to extensive discussion during the debate on the bill. There seemed to be an appetite
among the Senators to include such a provision in the bill as it works its way to becoming legislation.
Second, there have been proposals to effectively repeal part of IRS Notice 2007-55. This notice provided that,
among other things, a liquidating distribution by a REIT would be subject to tax as a distribution by the REIT
and would not be treated as a sale of stock (which is how liquidating distributions are generally treated under US
income tax rules). This provision was not included in the bill discussed above and, although the opportunity to
add such a provision may be possible in the future, there was no positive indication that such a provision was
likely to be included as this bill advances through the Congress.
For additional information concerning this issue, please contact:
Adam Feuerstein
703-918-6802
[email protected]
Real Estate Alert | February 2015
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PwC Real Estate Tax Practice – National and Regional Contacts:
National
David Voss
US RE Tax Leader
New York
646-471-7462
[email protected]
Regional
Atlanta
Dennis Goginsky
678-419-8528
[email protected]
Chris Nicholaou
678-419-1388
[email protected]
Steve Tyler
678-419-1224
[email protected]
Boston
Timothy Egan
617-530-7120
[email protected]
Rachel Kelly
617-530-7208
[email protected]
John Sheehan
646-471-6206
[email protected]
Chicago
Jill Loftus
312-298-3294
[email protected]
Alan Naragon
312-298-3228
[email protected]
Los Angeles
New York cont.
Adam Handler
213-356-6499
[email protected]
Oliver Reichel
646-471-5673
[email protected]
Phil Sutton
213-830-8245
[email protected]
Miranda Tse
213-356-6032
[email protected]
New York
Eugene Chan
646-471-0240
[email protected]
Dan Crowley
646-471-5123
[email protected]
James Guiry
646-471-3620
[email protected]
Sean Kanousis
646-471-4858
[email protected]
Christine Lattanzio
646-471-8463
[email protected]
Dallas
David Leavitt
646-471-6776
[email protected]
William Atkiels
214-754-5388
[email protected]
Marina Levin
646-471-6035
[email protected]
Paul Ryan
646-471-8419
[email protected]
San Francisco
Kevin Nishioka
415-498-7086
[email protected]
Neil Rosenberg
415-498-6222
[email protected]
Washington DC
Karen Bowles
703-918-1576
[email protected]
Adam Feuerstein
703-918-6802
[email protected]
Laura Hewitt
617-530-5331
[email protected]
Kelly Nobis
703-918-3104
[email protected]
James Oswald
646-471-4671
[email protected]
Real Estate Alert | February 2015
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