Among the reforms and provisions in the Protecting Americans From Tax Hikes Act of 2015 are several important changes to the Foreign Investment in Real Property Tax Act of 1980 (commonly referred to as FIRPTA) that are applicable to the disposition of US real estate (or interests in companies that, directly or indirect, hold US real estate) by non-US investors.
Structuring investments to address the effects of FIRPTA taxation is an integral consideration for any non-US investor that is considering investing directly or indirectly in US real estate. The Act includes a number of new provisions that may be available to certain non-US investors to exempt them from, or to clarify and expand existing exemptions from, the effects of FIRPTA on their US real estate investments.
Exemptions from FIRPTA for certain foreign retirement and pension funds. While US retirement and pension funds have generally been able to invest in US real estate transactions without being subject to US income tax, investments in US real estate by non-US retirement and pension funds have historically been subject to FIRPTA. The PATH Act, however, provides for an exemption from FIRPTA for non-US retirement and pension funds that dispose of (or that receive REIT distributions that are sourced from the disposition of) interests in US real estate, assuming the non-US retirement and pension funds satisfy several conditions. These conditions include (i) that the retirement or pension fund does not have a single beneficiary that is entitled to more than 5 percent of its assets, (ii) that the fund is subject to certain government regulation and reporting requirements, and (iii) that the fund – or investments in the fund – qualifies for certain tax exemptions under the tax laws of its resident jurisdiction. Significantly, the Act does not exempt tax on operating income and/or dividends from REITs, and therefore significant tax planning is still required for such investors.
Clarifications for domestically controlled REITS (and certain RICs). In general, if less than 50 percent of the value of certain “qualified investment entities” (specifically including REITs) that hold US real estate are owned by non-US investors, then the sale of stock in these entities (commonly referred to as “domestically controlled REITs” or “DC REITs”) are exempt from FIRPTA. Under certain circumstances (for example, in connection with certain widely held REITs and REITs that are subsidiaries of other REITs), the manner of determining whether the REIT qualified as a DC REIT was ambiguous under prior law. The Act allows a REIT to presume that any holder of less than 5 percent of any class of publicly traded stock in the REIT is a US person for determining the DC REIT status of the REIT (unless the REIT has actual knowledge to the contrary). This rule can allow non-US investors to achieve greater comfort that certain publicly traded REITs can qualify for DC REIT status without having to undertake the daunting task of trying to investigate the ultimate shareholders of all REIT stock. The Act also contains rules that clarify the status of a parent REIT in determining whether its subsidiary REIT can qualify for DC REIT status.
Publicly traded REIT stock. Under the current rules, an investor in a publicly traded REIT (or similar US real estate owning company) would be exempt from FIRPTA on either a capital gain dividend or a sale of such stock, provided the non-US investor held (directly or through attribution) no more than 5 percent of the stock in the REIT (or other entity) during a certain testing period. The Act modifies this FIRPTA exemption, for publicly traded REITs only, by expanding the provision to apply to non-US investors that hold (directly or through attribution) no more than 10 percent of the stock in the REIT during the testing period.
Certain publicly traded qualified shareholders. The Act provides for a new FIRPTA exemption for certain “qualified shareholders” in a REIT (even for REITs that are neither publicly traded nor DC REITs) except to the extent that an investor in that “qualified shareholder” holds, directly or through attribution, more than 10 percent of the stock in the REIT. In general, for the purposes of this exemption, “qualified shareholders” are limited to non-US publicly traded investors that satisfy certain other conditions and qualifications provided under the Act.
Increase in FIRPTA withholding rates. In general, the current FIRPTA withholding rate that applies to dispositions of US real estate by non-US investors is 10 percent. This will generally be increased under the Act to a 15 percent withholding rate beginning in February 2016.
Interests in REITs no longer subject to “cleansing rule.” In general, the sale of stock by a non-US investor in a corporation will not be subject to FIRPTA if, on the date of disposition of the stock by the non-US investor, the corporation no longer holds an interest in US real estate. This “cleansing rule” is a commonly used structuring technique for non-US investors that invest in US real estate (e.g., by causing a subsidiary US corporation to sell its interests in US real estate shortly before the disposition of the stock in the US corporation by the non-US investor). The Act provides that this rule will no longer apply to the sale of stock in a corporation that is (or that had a predecessor that was) a REIT.
Liberalizing FIRPTA for certain non-US investors
In sum, the Act provides for significant liberalization (and interpretive clarifications) of the application of FIRPTA to certain non-US investors. Such investors particularly include publicly traded non-US investors with characteristics similar to US public REITs, minority investors in US public REITs, and investments by non-US retirement and pension funds.