ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. 2015 Year-End Tax Act Clears a “PATH” to Foreign Investment in U.S. Real Estate Several US tax provisions specific to real estate investing were recently enacted as part of the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act” or “Act”) approved by President Obama in December of 2015. This brochure summarizes only those provisions affecting FIRPTA withholding on foreign investment in US real estate assets, and timber specific provisions. Certain foreign pension funds, and an expanded class of foreign REIT investors, are now exempt from FIRPTA. Other foreign investors face a 5% increase in FIRPTA withholding. Additionally, timberland owners/investors may benefit from other PATH Act provisions. PART I: FIRPTA—Generally FIRPTA effects the US income tax liability and withholding taxes imposed on foreign investors with certain direct and indirect ownership of US real property interests. United states real property interests include stock or ownership of an entity with US real property assets (which includes standing timber) representing 50% or more of its value (all of which are referred to as “USRPI”)), and certain distributions and allocations derived from USRPI dispositions. Effect on Income Tax. From the US income tax side, FIRPTA causes income from the sales of USRPI to be characterized as “effectively connected income” (or, “ECI”), and subjects foreign investors to tax on ECI on a net basis as if they were engaged in a US trade or business (“TOB”), at the same rates as US taxpayers. FIRPTA Withholding. It also imposes a separate withholding regime on sales of USRPI. The statutory FIRPTA withholding rate generally applies to the “amount realized” from the disposition of a USRPI, which in most circumstances is the sales price. The rate is generally 10% of the sales price, and for REIT shareholders 35% of dividends attributable to REIT sales of USRPI. Because FIRPTA applies to the amount received, rather than the gain or profit from such transaction, overwithholding is a common problem that requires foreign investors to file a US tax return in order to obtain a refund.1 A limited 1 Foreign investors are characterized and taxed, for US income tax purposes as either (i) individuals or trusts, or (ii) corporations. Individuals and trusts benefit from the preferential income tax rate on long-term capital gains (20%) vs. the top marginal rate on ordinary income (39.6%). Corporations do not have a preferential rate for capital gains and all income is taxed at the same rate regardless of character. The top corporate rate is currently 35%. (NOTE: the Act provides a limited exception whereby a corporation’s “qualified timber gains” may be taxed at a preferential rate of 23.8%, discussed below in Part III). number of exceptions, and the possibility to file with the IRS for a reduced withholding amount to more closely approximate the actual US federal income tax liability exist, but require pre-planning. PART II: FIRPTA – Post PATH Act Winners. The primary beneficiaries under the PATH Act are certain REIT investors and “qualified foreign pension funds,” both of which are now exempt from FIRPTA. REIT Shareholders. Prior to the PATH Act, the only exceptions to the FIRPTA withholding rules for REITs applied to the sale of shares of a “domestically controlled REIT” and for shareholders of publicly traded REITS with a 5% or less ownership. Now, foreign investors with holdings of 10% or less of publicly traded REITs, and foreign pension plans meeting the definition of a QFPF (see below), are exempt from FIRPTA. Foreign Pension Plans. Prior to the Act, the designation of a foreign pension plan as a “trust” for US federal income tax purposes was a murky area. The US tax classification rules for trusts clearly apply to US formed pension trusts, but not foreign pension plans that have more of a corporate-type structure but which otherwise serve the same purpose and operate under similar rules in their home country as US pension & benefit plans. The PATH Act now exempts foreign pension funds meeting the definition of a “qualified foreign pension fund” (hereinafter, a “QFPF”) from FIRPTA withholding and ECI classification of such income. For FIRPTA purposes (but not necessarily for US income tax classification purposes), a QFPF is any trust, corporation, or other organization or arrangement: (i) created or organized outside of the US; (ii) established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or persons designated by those employees) of one or more employers in consideration for services rendered; (iii) which does not have a single participant or beneficiary with a right to more than 5% of its assets or income; (iv) which is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates; and (v) contributions are either deductible or excludable from income tax for the entity or the taxation is deferred or subject to a lower rate of tax in its country of formation or operation. See the charts in Part IV comparing the withholding rates. Losers. For all other foreign investors, the FIRPTA bite is bigger. FIRPTA on Sales/Dividends. A foreign investor (other than certain REIT shareholders or QFPF, as explained in the preceding paragraphs) selling a USRPI is now subject to a 50% increase in withholding tax under FIRPTA (15% withholding rate on the sales price vs. 10% prior to PATH Act). This withholding tax applies to sales of real property and standing timber sales (including those by a disregarded LLC), as ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. well as sales of interests of entities having 50% or more of their assets comprised of USRPI, (including sales of REIT shares unless in the class of shareholders above described). Dividend distributions from a REIT to a foreign shareholder (other than those REIT shareholders exempted as above described) derived from the REIT’s sale of a USRPI (which includes standing timber) are subject to a FIRPTA withholding rate of 35%, which the Act did not change. For foreign trusts and individuals able to utilize the preferential capital gains rate of 20% (of net gain/profit), both the 15% withholding on the sales price of USRPI dispositions and the 35% withholding under FIRPTA on REIT dividend amounts can create a significant distortion between the amount of tax withheld and the actual tax liability. Mitigating Increased FIRPTA Withholding. Such investors would be well advised to consider obtaining a reduced withholding certificate from the Service to eliminate the time value of money and refund filing cost of a tax overpayment, or to consider alternative structures. Our team would be happy to assist you with this process. FIRPTA on Partnership Allocations and Distributions. Allocations and distributions from entities considered partnerships for US tax purposes to foreign partners are not subject to FIRPTA if such entities are engaged in a US trade or business. Partnerships and LLCs are not “blockers” and their trade or business activity is imputed to their partners/members, which are taxed on such income (ECI) as if they were US taxpayers. Partnership withholding of ECI under Code § 1446 of the Internal Revenue Code of 1986, as amended (the “Code”) trumps Code § 1445 FIRPTA. Section 1446 states that if a partnership has ECI or income deemed to be ECI, the partnership must withhold on such ECI allocable (whether or not distributed) to foreign partners. In plain language, this means that commercial real estate development and timberland operations, for instance, constitute a US trade or business and generate ECI subject to withholding at the partnership level (20% for ECI constituting LTCG and 39.6% for other ECI, allocable to foreign individual and trusts, and 35% on amounts allocable to foreign corporations). The ECI partnership withholding thus much more closely approximates the foreign partner’s US income tax liability, and the withholding issue is not as acute as under FIRPTA. This withholding applies even if the partner is a QFPF. PART III: Timber Specific Provisions C-Corps receive temporary break for timber gains. Prior to the PATH ACT, a corporation could pay an alternative tax of 35%, which is roughly equal to what the top corporate tax rate has been for the last 27+ years (other than temporary relief in 2008 TREE Act) on the lower of net capital gains or timber gains. The Act contains a temporary benefit for corporations with long-term timber holdings. For the 2016 tax year, a corporation’s income tax liability may be spliced with a portion (the lesser of net capital ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. gains or net “qualified timber gain”) eligible for a tax rate of 23.8% (which is the amount a US individual or trust would pay on such gains, 20% plus 3.8% investment income surtax), and the remaining excess capital gain taxed at the ordinary corporate rate. The trick is that “qualified timber gain” requires a 15- year holding period, and timber must be harvested pursuant to a 631(a) election (for log sales or use in the taxpayer’s TOB) or sold pursuant to a 631(b) disposition (for stumpage sales). Opportunities for Conservation Easement Deduction. Of significance to US and foreign high net worth/high income individuals and trusts investing in US timberland assets, the PATH Act makes permanent the deduction for a donation of a qualified contribution easement. A trust or individual (both US and foreign) may deduct the amount of the contribution up to 50% of adjusted gross income. The excess contribution amount from a conservation easement may be carried forward for 15 years. Timberland investments are particularly well suited for conservation easement donations. The typical activities on most timberland investments are sustainable harvesting, hunting and recreational use, all of which are permissible post-donation activities. The donor can benefit from the current deduction (or monetization thereof through a structured partnership arrangement) while enjoying the historic use and enjoyment of the property. Conclusions: • Currently, the definition of a QFPF applies only with regard to FIRPTA withholding, not necessarily to the classification of a QFPF as a “trust” for US income tax purposes (and thus eligible for the preferential LTCG rate). It will be interesting to see if the Service adopts this as a “per-se” definition of a trust for US tax classification of foreign pension plans and/or if the number of taxpayer classification determination letters requested from the IRS increases as a result. • For US real estate investment activity that rises to the level of a US trade or business (commercial real estate development and most timberland investments), the REIT vehicle is considerably more appealing now for foreign pension funds meeting the “QFPF” definition. Dividends constituting capital gain and sales of REIT shares are now exempt from both FIRPTA withholding and US income tax. The burden of filing for a refund of FIRPTA over withholding has been removed. The cost of REIT formation and compliance is mitigated by the improved after-tax returns for QFPF investors. • Private timber REITs are considerably more attractive now for QFPF investors as such REITs generate a high ratio of capital gain dividend relative to other types of REITs. • For other foreign investors, the FIRPTA withholding is now 50% greater (15% of sales price) than before the PATH Act. The potential for and cost of over-withholding is more acute now for those investors, which may do well to consider planning to apply for a reduced withholding certificate ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. prior to significant USRPI sales or dispositions. Buyer’s advisors and escrow agents should update their FIRPTA witholding forms and procedures with the new 15% rate. • Now that the deduction for a qualified conservation easement is permanent, high net worth/high income individuals and trusts (both foreign and domestic) may plan with certainty the monetization of timberland assets through strategic conservation easement donations, yet still engage in typical harvesting and recreational activities on the properties. • Corporations with long-term timberland holdings may utilize a temporary C-corporation tax of 23.8% on “qualified timber gains” for the 2016 tax year. Our team of tax and real estate partners has a unique combination of experience with REITs, timberland investment and conservation easements. To discuss how any of the above provisions impact your current or proposed investment, please feel free to reach out to the below partners. Click on their names for more information on their expertise in these areas. Karen Reschly firstname.lastname@example.org Kenneth Krasny email@example.com Dolph Winders firstname.lastname@example.org Please see the next two pages for Part IV: FIRPTA withholding charts. ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. PART IV: FIRPTA Comparison Charts FIRPTA Withholding Rates After the PATH Act of 2015 Investment Vehicle Applicable FIRPTA Withholding Private REIT --Dividends 35% withholding on portion of dividends attributable to REIT sale of USRPI (includes land and timber sales), unless shareholder is a QFPF, which is now exempt from FIRPTA. --Sale of Shares 15% withholding, unless shareholder is QFPF, or the REIT is domestically controlled, in which case no FIRPTA withholding. Publicly Traded REIT --Dividends No FIRPTA for shareholders with 10% or less ownership or QFPF shareholders, otherwise 35% withholding on portion of dividends attributable to REIT sale of USRPI. --Sale of Shares No FIRPTA for shareholders with 10% or less ownership or QFPF shareholders, or if REIT is domestically controlled. Otherwise subject to 15% withholding. Private USRPHC C-Corp --Dividends No FIRPTA withholding on dividends. --Sale of Shares 15% withholding, unless shareholder is a QFPF, in which case no FIRPTA. Publicly Traded USRPHC C-Corp --Dividends No FIRPTA withholding on dividends. --Sale of Shares 15% withholding unless shareholder owns 5% or less, or is a QFPF, in which case no FIRPTA. NOTES: Please note these tables reflect only the withholding applicable under FIRPTA on amounts deemed to be derived from the sale or disposition (direct or indirectly) of a USRPI by a foreign investor. Other withholding obligations, and US income tax may also apply. Foreign investors and investment managers of foreign clients should consult with tax professionals experienced in this complex area of the US tax system. KEY: “QFPF”and “FIRPTA” are defined in the narrative portion of this brochure. [See Following Page for Partnership Withholding] ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. FIRPTA Withholding Rates After the PATH Act of 2015 Investment Vehicle Applicable Partnership Withholding for Foreign Individual and Trust Partners Applicable Partnership Withholding for Foreign Corporation Partners US Partnership or LLC classified as a partnership: --Allocations and Distributions --Sale or disposition of partnership interest If the partnership is engaged in a US TOB (as is the case with most real estate and timber investing) the PATH Act did not affect withholding requirements under § 1446. § 1446 allows withholding rate of 20% of LTCG, and 39.6% for other ECI income allocable to the foreign partner (whether or not distributed) which includes partnership sales of USRPI’s. 35% of partnership income allocable to the partner (whether or not distributed) constituting ECI, which includes partnership sales of USRPI’s. Sale price now subject to a 15% withholding, unless transferor/ seller is a QFPF, in which case it is exempt from FIRPTA (0% withholding) on the sale or disposition. Sale price now subject to a 15% withholding, unless transferor/seller is a QFPF, in which case it is exempt from FIRPTA (0% withholding) on the sale or disposition. Publicly Traded US Partnership: --Allocations and Distributions --Sale or disposition of partnership interest Distributions allocable to partnership income constituting ECI subject to 35% withholding tax. Distributions allocable to partnership income constituting ECI subject to 35% withholding tax. Sale price now subject to a 15% withholding, unless transferor/seller is a QFPF, in which case it is exempt from FIRPTA (0% withholding) on the sale or disposition. Sale price now subject to a 15% withholding, unless transferor/seller is a QFPF, in which case it is exempt from FIRPTA (0% withholding) on the sale or disposition. NOTES: Please note these tables reflect only the withholding applicable under the Partnership ECI regimes. Other withholding and US income tax rules may also apply. Foreign investors and investment managers of foreign clients should consult with tax professionals experienced in this complex area of the US tax system. KEY: “LTCG,” “QFPF,” “FIRPTA” are defined in the narrative portion of this brochure. ATLANTA AUSTIN BOSTON CHARLOTTE CHICAGO CINCINNATI CLEVELAND COLUMBUS DALLAS DETROIT HOUSTON LOS ANGELES NAPLES NEW YORK PALO ALTO PHILADELPHIA PRINCETON SEATTLE WASHINGTON D.C. FisherBroyles, LLP - Cloud-based. Not Virtual™ Founded in 2002, FisherBroyles, LLP was the first in the U.S., and now the largest full-service, cloudbased law firm in the world. The Next Generation Law Firm® has grown to approximately 150 attorneys in 19 offices nationwide. 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