Foreign investors in U.S. real estate as well as sellers of domestic real estate to foreign investors should be aware of changes in the FIRPTA (Foreign Investment Real Property Tax Act) brought on by a new amendment signed into law called PATH (Protecting Americans from Tax Hikes Act of 2015).
On December 18, 2015, the President signed PATH which effectuated significant changes in FIRPTA. Congress originally passed FIRPTA in efforts to achieve parity, or level the playing field, between domestic and foreign investors in U.S. real property. PATH included an increase in the rate of withholding of foreign dispositions from 10% to 15%. This increase was put in place to collect a greater amount of the potential tax owed on disposition of U.S. real property by foreign investors. “Disposition” includes sales, gifts, redemptions and capital contributions. Additionally, PATH impacted foreign pension funds and eased restrictions on U.S. Real Estate Investment Trusts for foreign investors in U.S. real estate.
Rate Increase for Foreign Dispositions
The tax is applied to the actual amount realized by the foreign seller. The transferee (buyer or recipient) of the foreign disposition is responsible for withholding the 15% tax from the foreign seller and remitting it to the IRS. This requires the transferee be responsible for determining whether the transferor is a foreign national. If the transferee is mistaken as to transferor’s foreign status and fails to withhold the tax, the transferee is then held liable. However, if the disposition realizes an actual value of zero, such as with a gift, no tax rate is applied.
There are some “exemptions” to the amended increase. Section 1445(b) of FIRPTA states a previously existing exception (existing before the increase) that states if the amount realized is less than $300,000 AND the transferee intends to use the property as a residence, then no amount need be withheld. The increase creates two situations dealing with actual amount realized:
- If the amount realized by the foreign seller exceeds $300,000 but does not exceed $1,000,000, AND the transferee intends to use the property as a residence, the previous 10% rate applies, rather than the 15% rate.
- If the amount realized by the foreign seller exceeds $1,000,000, then the new 15% rate applies, regardless of how the transferee intends to use the property and for how long.
Both domestic and foreign investors in U.S. real property should be alerted to future changes in regulation that could bring about another change in existing procedures. Transferees should be diligent about determining the seller’s foreign status before closing in order to avoid liability. The new increase will apply to all transactions closing on or after February 16, 2016.
Restrictions Eased on U.S. Real Estate Investment Trusts
The amendment also impacted U.S. Real Estate Investment Trusts for foreign investors. Before the recent changes, foreign investors in “REITs” that held a 5% or more stake had to pay a tax if they sold their stock or if the REIT paid out capital gains on dividends. The amendment raises the threshold from 5% to 10%. This allows investors who hold less than a 10% instead of a 5% stake to avoid being taxed. Additionally, REITs no longer have to prove that they are more than 50% domestically controlled.
Before the act, it was difficult to determine if more than 50% of the stock was domestically controlled. Some, if not many, investors held a 5% or less stake in the REIT and oftentimes it was difficult to determine if they had a domestic or foreign base. This obstacle has been eliminated by PATH and leave the REIT room to attract more foreign investors.
Foreign Pension Plan Changes
New section 897(I) relieves foreign pension funds that are investing in U.S. real property from the FIRPTA withholding when the sell their real estate assets. The must of course meet certain threshold requirements, however PATH now puts them on equal footing with domestic pension fund investors. It should be noted that the PATH exemption only applies to U.S. real estate property interest held directly or indirectly by one or more partnerships or to distributions received from REITs by a qualified foreign pension fun. This change will apply to distributions and dispositions of real estate made after December 18, 2015.
Look for future posts which will discuss planning and strategies for structuring foreign investments in U.S. real estate.
Katie Evans | McCullough Sudan PLLC