The U.S. has undergone a number of statutory and regulatory changes during 2016. Below is a short synopsis of those which will likely have the most significant impact on US real estate (which generally includes timber, agricultural and mining assets) investors, advisors and managers.
FIRPTA Withholding: In December of 2015 the PATH Act changed the FIRPTA (acronym for Foreign Investment in Real Property Tax Act of 1980) withholding rates. FIRPTA is a U.S. withholding tax triggered when non-U.S. persons or entities sell U.S. real property interests, which includes an entity with more than 50% of its assets comprised of real property. Both land and standing timber are considered real property interests. The FIRPTA withholding tax is generally imposed on the sales price, rather than taxable gain. This usually results in over-withholding and requires foreign investors to file a U.S. income tax return to obtain a refund.
Prior to the PATH Act, the standard rate of FIRPTA withholding was 10%. The tax burden is now 50% greater, with a rate of 15%. For certain real estate investment trust (“REIT”) investors, the PATH Act lowered the FIRPTA withholding rate. Previously, REIT dividends were generally subject to a FIRPTA rate of 35% on dividends attributable to dispositions of U.S. real property interests (land and most standing timber sales). Also, investors in a “domestically controlled REIT,” or 5% or less shareholders in a public REIT, were exempt from FIRPTA withholding on the sale of their shares. Now, foreign pension funds are exempt from FIRPTA withholding on both dividends and the sale of shares. Additionally, the publicly-traded REIT ownership threshold was increased from 5% to 10%. The big winner is foreign pension funds, which may now escape U.S. income tax on both REIT capital gain dividends and share sales.
Foreign-Owned Disregarded Entity Reporting: In May of 2016, the US Treasury released proposed regulations that would require U.S. domestic limited liability companies (“LLCs”) which are wholly-owned by foreign persons to obtain a U.S. tax identification number and file an annual return (Form 5472). Transactions between the LLC and its foreign owner would be reported to the Internal Revenue Service (“IRS”). “Transactions” in the proposed regulation include, but are not limited to, contributions, distributions, sales, loans and service agreements. If the proposed regulations are adopted, a single member LLC and its non-U.S. owner will both be required to file separate returns with the IRS.
SEC Revisions to Form ADV and Advisers Act Rules: On August 25, 2016, the Securities and Exchange Commission (“SEC”) adopted revisions to Form ADV, which will become effective October 1, 2017. Investment advisers registered under the Investment Advisers Act of 1940, as amended (“Advisers Act”), Exempt Reporting Advisers, and state-registered investment advisers are currently required to complete at least certain portions of Part 1 of the Form ADV.
- Separate Accounts: Under the Form ADV revisions, all of those investment advisers described above will be required to provide substantially more information with regard to separately managed accounts (“SMAs”) than was previously required. The level and frequency of disclosure required depends upon the total amount of separate account regulatory assets under management (“RAUM”) attributable to a particular investment adviser. The SMA disclosure regime is broken down into three tiers separated at $10 billion and $500 million in SMA RAUM. The most significant new disclosures relate to the type of assets held in SMAs, the use of derivatives and borrowing, and the identity of SMA custodians.
- Performance Communication Recordkeeping: Additionally, the SEC amended the record-keeping requirements under the Advisers Act applicable to SEC-registered investment advisers. Under the amended rule, SEC registered investment advisers will now be required to maintain documentation which demonstrates the calculation of the performance or rate of return in any written communication that the adviser circulates or distributes, directly or indirectly, to any person. Prior to the amendments, such recordkeeping would only be required if such communications are distributed to ten (10) or more persons. The scope of the new requirement will pick up calculations requested by a single investor (and even a potential investor). Additionally, advisers will be required to retain originals of all written communications describing performance or rate of return that are received from any third party and copies of all written communications sent to third parties. We recommend that registered investment advisers update their compliance policies and procedures to reflect these changes.