Major Reforms to the Foreign Investment in Real Property Tax Act (FIRPTA)
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On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act of 2015, which includes major reforms to the Foreign Investment in Real Property Tax Act of 1980.
FIRPTA imposes United States federal income tax on foreign investors on gain from the disposition of a United States real property interest (USRPI). To guarantee the collection of tax under FIRPTA, a withholding obligation is imposed on certain transferees of USRPIs.
Among the key provisions, the PATH Act increases the FIRPTA withholding rate on the purchase of a USRPI from a foreign person from 10 percent to 15 percent and provides an exemption for foreign pension funds from taxation under FIRPTA when certain conditions are satisfied.
Introduced in 1980, FIRPTA subjects foreign persons to United States federal income tax on gain from USRPIs. Subject to certain exceptions, a USRPI includes stock in a United States corporation that holds USRPIs, the value of which equals or exceeds 50 percent of the value of the corporation’s total real property holdings (foreign and U.S.) plus other assets which are used or held for use in a trade or business (such corporations are known as United States real property holding corporations or USRPHCs).
Under FIRPTA, upon the disposition of a USRPI by a foreign person, such person must report the gain or loss as if it were effectively connected with a United States trade or business (ECI) and pay tax on any net gain at rates applicable to United States persons. The FIRPTA rules also impose a withholding obligation on persons acquiring USRPIs (transferees) from foreign persons.
Narrow exemptions from FIRPTA exist. The PATH Act expands available exemptions and thereby increases the appeal of United States real property investments for many investors.
FIRPTA Withholding Rate Increased to 15 Percent
Key FIRPTA Reforms
As discussed above, the PATH Act increases the FIRPTA withholding rate from ten percent to 15 percent on the purchase of a USRPI from a foreign person and is effective 60 days after enactment of this provision.
New FIRPTA Exemption for Foreign Pension Funds
The PATH Act also provides a new and complete exemption for qualified foreign pension funds (including their wholly-owned subsidiaries) from taxation under FIRPTA. Specifically, the PATH Act provides an exemption from FIRPTA for foreign pension funds meeting the following requirements: the fund is created or organized under the law of a country other than the United States; the fund is 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; the fund must not have a single participant or beneficiary with a right to more than five percent of its assets or income; and the fund must be subject to government regulation and provide annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it operates, and under such laws either (i) contributions made to it are deductible or excluded from the gross income or taxed at a reduced rate, or (ii) taxation of any of its investment income is deferred or taxed at a reduced rate.
Increased Exemption for Publicly Traded Interests
The PATH Act also increases the size of shareholdings of publicly-traded REITs that are exempt from FIRPTA to ten percent, from the previous five percent exemptions.
Foreign investors can now hold up to ten percent of a publicly traded REIT’s stock without triggering FIRPTA upon the disposition of such stock or upon distributions from the REIT that are attributable to gain from the sale or exchange of a USRPI.
New Exemption for Qualified Shareholders of REITs
The PATH Act provides another new exception from FIRPTA for certain “qualified shareholders” of REITs. Only certain foreign persons can be eligible for “qualified shareholder” status, provided they meet a series of specific requirements. For instance, if it meets the necessary criteria, a publicly traded foreign mutual fund may be able to qualify.
Cleansing Rule No Longer Applies to REITs and RICs
Generally speaking, FIRPTA does not apply to the gain recognized upon the sale of shares of a USRPHC if all of the USRPHC’s USRPIs were disposed of in transactions in which the full amount of the gain was recognized during a testing period, and the USRPHC did not hold any USRPIs as of the date of the share sale. This is known as the “FIRPTA cleansing rule,” and is based on the rationale that tax on the gain from USRPIs has already been imposed. The PATH Act provides that the cleansing rule no longer applies to United States corporations that have been REITs or regulated Investment Companies (RICs) during the relevant testing period.
Domestically Controlled REIT Criteria Clarified
Under FIRPTA, a foreign investor does not treat stock of a “domestically controlled” REIT as a USRPI. The PATH Act provides for some guidance in determining whether or not a REIT is domestically controlled. Most notably, less-than-five percent shareholders of any class of REIT stock that is regularly traded on a recognized United States securities market are generally presumed to be United States persons. Special rules apply to REIT stock owned by other REITs or RICs.
How BDO Can Help
BDO has the knowledge and expertise to help clients evaluate their FIRPTA exposure and comply with FIRPTA tax and withholding obligations.
For more information, please contact one of the following regional practice leaders: