On December 18, 2015, the United States Congress enacted the Protecting Americans from Tax Hikes Act of 2015 (the Act). Among other things, the Act permanently extends many “popular” tax provisions (e.g., the research and development tax credit) that were previously “temporary” and significantly modifies the Foreign Investment in Real Property Tax Act of 1980 (known as FIRPTA). The modifications to FIRPTA are intended to, and most likely will, increase foreign investment in United States real property.
Generally, FIRPTA requires foreign taxpayers to file and pay income tax on the gain resulting from the disposition of a United States real property interest (USRPI). To promote tax compliance, sellers of USRPIs are required to withhold ten percent (10%) on gross proceeds. The Act increases the withholding tax rate to fifteen percent (15%) of gross sales proceeds. Foreign sellers are then typically required to file a U.S. tax return to declare the sale and, as appropriate and according to the actual U.S. tax owed on the sale, request a refund. The increase in the FIRPTA withholding tax under the Act may result in foreign sellers more often seeking U.S. FIRPTA withholding tax exemption certificates in advance of the sale of U.S. real property.
For purposes of FIRPTA, a USRPI includes any interest, other than solely as a creditor, in real property located in the United States or the U.S. Virgin Islands and interests, other than solely as a creditor, in certain domestic corporations that hold significant amounts of USRPI, known as United States real property holding corporations (USRPHC). A domestic corporation generally is presumed to be a USRPHC and, consequently, a sale of USRPHC stock by a foreign person is subject to FIRPTA withholding taxation unless it is established prior to the sale that the corporation was at no time a USRPHC during the 5-year period ending on the date of disposition or unless the seller timely obtains from the Internal Revenue Service a FIRPTA withholding exemption certificate.
The Act includes two significant and long-lobbied for changes to the current taxation scheme imposed under FIRPTA. First, the Act expands the current FIRPTA exemption available to certain shareholders of publicly-traded corporations. Real estate investment trusts (REITs), including publicly-traded REITs, typically constitute a USRPHC based on their asset composition. Consequently, the disposition of a REIT interest may be subject to taxation and withholding under FIRPTA unless otherwise exempted. FIRPTA currently exempts certain classes of publicly-traded stock of a domestic corporation from the definition of a USRPI if held by a person who did not own (directly or constructively) more than five percent (5%) of that class of stock. The Act doubles the current FIRPTA tax exemption for foreign shareholders in publicly-traded REITs from the current five percent (5%) threshold to a ten percent (10%) threshold. In addition, the Act completely exempts foreign pension funds investing in United States commercial real estate from FIRPTA taxation.
By expanding these FIRPTA exemptions, the Act promotes investment in United States real estate especially for foreign pension funds and with regard to large foreign investment groups structuring U.S. real estate investment through REIT vehicles. By enlarging the current FIRPTA exemption in the context of REITs, the Act provides advantages to REITs as a tax-preferred vehicle for investment in United States real estate. Accordingly, based on the current positive investment climate and the congressional preference demonstrated by the Act, REITs could become a more popular vehicle for United States real estate investments by foreign taxpayers.
The publicly-traded stock and foreign pension fund exemptions took effect on December 18, 2015 and will apply to dispositions and distributions made on or after that date. The increased FIRPTA withholding tax rate of fifteen percent (15%), however, will take effect 60 days after the Act’s date of enactment.