Positive news for foreign investors in US real estate

The new US budget bill makes several long-sought revisions to the Foreign Investment in Real Property Tax Act (FIRPTA).  The reforms will have a positive impact on foreign investors in US real estate. 

10th February 2016

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Will the new US budget bill affect domestic real estate?

Yes; the Protecting Americans from Tax Hikes Act of 2015 (PATHA) makes several long-sought revisions to the Foreign Investment in Real Property Tax Act (FIRPTA).

FIRPTA was enacted by Congress in 1980 in response to concerns about increasing foreign ownership of US real estate. It subjects non-US investors in US real property to taxation on any capital gain realised at property disposition. Foreign investors had previously been able to structure US real estate investments so that they could escape income tax on any capital gains. They could accomplish this post-FIRPTA only by ceding control to partners and holding a minority stake in US properties. FIRPTA tax requirements also apply to interests in partnerships and to stock of US real property holding corporations, including publicly traded REITs.

What are the specific reforms?

(a) The new act completely exempts qualified foreign pension funds, as well as entities wholly owned by such funds, from taxation on capital gain realised at property disposition.  Foreign and domestic pension funds will now receive equal treatment when disposing of US real property interests.

(b) FIRPTA did not apply if non-US investors held 5% or less of the publicly traded stock of a US real property holding corporation. This small interest exemption is now raised to 10% only for publicly traded REITs; it remains 5% for other types of publicly traded property companies.

(c) Foreign publicly traded entities that are created in jurisdictions with both a comprehensive income tax treaty and an information sharing agreement with the US on tax-related issues (“qualified shareholders”) may now own and dispose of any amount of stock in a publicly traded US REIT without triggering capital gains tax in the US.

(d) FIRPTA exempted from tax any gain from sale or disposition of the stock of a “domestically controlled” qualified investment entity. A REIT or real property investment company (RIC) is domestically controlled if at least 50% of its stock value is owned by US persons. It has been difficult for publicly traded REITs and RICs to take advantage of this exemption, however, because they often lack information about the country of origin of shareholders owning less than 5% of their stock. Under the new act (PATHA), shareholders with less than 5% of stock in a regularly traded REIT or RIC will be presumed to be US persons, absent actual knowledge to the contrary on the part of the REIT or RIC. Additional definitional changes and clarifications further ease use of this exemption.

What impact will these reforms have for foreign investors in US real estate?
The reforms level the playing field for foreign pension funds seeking equity investments in US real estate. The volume of foreign pension capital flowing to US real estate is expected to increase substantially as a result. Foreign investors have thus far seemed indifferent to the strong US dollar; the changes will bolster already above-average inflows. Pension funds will also begin to invest differently. Following the revisions, foreign pension funds can hold full or majority ownership without triggering capital gains tax, enabling them to maintain better control over their US property investments. The doubling of the small interest exemption and the exception that PATHA provides for qualified shareholders should also attract additional foreign capital into the US public REIT market. Since these two changes apply to all foreign investors, scope for expansion in this area is considerably greater.

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