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Foreign Investment in U.S. Real Estate – A F.I.R.P.T.A. Introduction

Foreign Investment in U.S. Real Estate – A F.I.R.P.T.A. Introduction

Many economic, political, and cultural factors make U.S. real estate an attractive investment for high net worth individuals resident in other countries.  These factors are supported by a set of straightforward tax rules that apply at the time of sale.  Alicea Castellanos, the C.E.O. and Founder of Global Taxes L.L.C., looks at the U.S. Federal income taxes and reporting obligations that apply to a foreign investor from the time U.S. real property is acquired to the time of its sale.

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Sale of a Partnership Interest by a Foreign Partner – Is Rev. Rul. 91-32 Based on Law or Administrative Wishes?

Sale of a Partnership Interest by a Foreign Partner – Is Rev. Rul. 91-32 Based on Law or Administrative Wishes?

The I.R.S. has a long history in misapplying U.S. tax rules applicable to a sale of a partnership interest.  For U.S. tax purposes, a partnership interest is treated as an asset separate and apart from an indirect interest in partnership assets.  In Rev. Rul. 91-32, the I.R.S. misinterpreted case law and Code provisions to conclude that gains derived by foreign investors in U.S. partnerships are subject to tax.  No one thought the I.R.S. position was correct, but then, in a field advice to an agent setting up an adjustment, the I.R.S. publicly stated that the ruling was a proper application of U.S. law when issued and remains so today. The adjustment was challenged in the Tax Court, and the tax bar is eagerly awaiting a decision.  Stanley C. Ruchelman and Beate Erwin examine the I.R.S. position, the string of losses encountered by the I.R.S. when challenged by taxpayers, and the Grecian Magnesite case awaiting decision.

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P.A.T.H. Act Leads to Widespread Tax Changes

Everyone likes Christmas presents and the P.A.T.H. Act delivers. It provides favorable tax treatment in the form of (i) F.I.R.P.T.A. exemptions for foreign pensions funds, (ii) increased ownership thresholds before F.I.R.P.T.A. tax is imposed on C.I.V. investment in R.E.I.T.’s, (iii) increased ownership thresholds before F.I.R.P.T.A. tax is imposed on foreign investment in domestically-controlled R.E.I.T.’s, (iv) a reduction in the time that must elapse in order to avoid corporate level tax on built-in gain when an S-election is made by a corporation after the close of the year of its formation, and (v) a permanent exemption from Subpart F income for active financing income of C.F.C.’s.

However, not all taxpayers benefitted from the Act. The P.A.T.H. Act increases F.I.R.P.T.A. withholding tax to 15%, adopts new partnership tax examination rules, and tightens rules regarding I.T.I.N.’s. Elizabeth V. Zanet, Christine Long, Rusudan Shervashidze, and Philip R. Hirschfeld explain these and certain other legislative changes.

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Foreign Investment in U.S. Real Estate – Think About Taxes Before Investing

Published in Journal of Taxation of Investments, Volume 32, Number 3: Spring 2015. © Civic Research Institute. Authorized Reprint.

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Indian Investors Purchasing U.S. Real Estate – From a U.S. Point of View

Published in International Taxation, Volume 13, Issue 3: September 2015.

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I.R.S. Proposed New Partnership Rules Under Code §956

The I.R.S. recently released temporary and proposed regulations to limit the use of foreign partnerships to avoid income inclusions under Code §956. The Temporary Regulations are more limited in their scope while the Proposed Regulations are quite broad. If finalized in the current form, the Proposed Regulations would cause most C.F.C. loans to partnerships with related U.S. partners to be investments in U.S. property.

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Legislation to Relax F.I.R.P.T.A. Gets Bipartisan Support

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Tax legislation to encourage foreign investment in U.S. real estate made through real estate investment trusts (“R.E.I.T.’s”) was recently introduced in both the House and the Senate. Representatives Kevin Brady (R-T.X.) and Joe Crowley (D-N.Y.), introduced H.R. 2128, the “Real Estate Investment and Jobs Act of 2015.” The measure, backed by 22 bipartisan members of the U.S. House of Representatives, would make significant changes to the Foreign Investment in Real Property Tax Act (“F.I.R.P.T.A.”). The bill is similar to legislation Representatives Brady and Crowley introduced in the last session of Congress, as well as a companion version introduced in the U.S. Senate this year, co-authored by Senators Mike Enzi (R-W.Y.) and Bob Menendez (D-N.J.), S. 915. The Senate version would adopt additional changes including a proposed increase in F.I.R.P.T.A. withholding tax rates that would complicate investing by those not benefitting from the proposals. Enactment of the significant provisions in H.R. 2128 and S. 915 would signify an important step toward achieving F.I.R.P.T.A. reforms that have been advocated for by a number of real estate organizations for many years.

R.E.I.T. QUALIFICATION

A R.E.I.T. is a creation of the tax law. Any corporation, trust, or unincorporated entity may qualify as a R.E.I.T. if it meets the requirements of Code §856. A benefit of R.E.I.T. status is that it is a conduit for tax purposes, provided distributions are made to shareholders. No tax is imposed on the R.E.I.T. if it distributes all its income to its owners. The R.E.I.T. claims a deduction for dividends that it pays to its shareholders. In addition, a shareholder of the R.E.I.T. may be able to treat a dividend from the R.E.I.T. as taxable at capital gains rates if the underlying income of the R.E.I.T. that generates the dividend arises from the sale of an asset.

Using a §897(i) Non-Discrimination Election to Avoid F.I.R.P.T.A.

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Mistakes happen. Often nonresident alien individuals buy U.S. real property, often personal use property, in their individual names. This can be a costly mistake. With certain exceptions, if such an individual were to die while owning the property, a U.S. estate tax of approximately 40% of the value of the property could be imposed.

There is one method to restructure this investment in the case of a foreign individual, or an entity owned by a foreign individual, if such a person is eligible to claim the benefit of an income tax treaty with the United States and the treaty contains a so-called “Nondiscrimination Clause.” These clauses provide that a resident of a treaty state will not be treated any less favorably than a U.S. resident carrying on the same activities. This article will look at how a Nondiscrimination Clause can be used to avoid onerous F.I.R.P.T.A. provisions when a foreign person invests in U.S. real property.

The technique described in this article essentially permits a nonresident alien individual to transfer U.S. real property on a tax-free basis to a foreign entity, which will be treated as a domestic entity for income tax purposes and as a foreign (non-taxable) entity for U.S. estate tax purposes.

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property – Part III

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INTRODUCTION

This is the final article in a three-part series that explains U.S. taxation under the Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”). This article looks at certain planning options available to taxpayers and the tax consequences of each.

These planning structures aim to mitigate taxation by addressing several different taxable areas of the transaction. They work to avoid gift and estate taxes, and double taxation of cross-border events and corporate earnings, while simultaneously striving for preferential treatment (e.g., long-term capital gains treatment), as well as limiting over-withholding, contact with the U.S. tax system, and liability. Often, such structures are helpful in facilitating inter-family transfers and preserving the confidentiality of the persons involved.

PRE-PLANNING

As with everything else, planning can go a long way when it comes to maximizing U.S. real estate investments. Here are a few questions to ask:

Investor Background

  1. Where is the investor located?
  2. Where is the investment located?
  3. What kind of business is the investor engaged in?

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property - Part II

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This article examines the U.S. income, gift, and estate tax consequences to a foreign owner upon a sale or other disposition of U.S. real property, including a sale of real estate, sale of stock of a U.S. corporation, or a sale of a mortgage secured by U.S. real property.

In addition to (or sometimes in lieu of) rental income, many foreign investors hope to realize gain upon a disposition of U.S. real property. The Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”) dictates how gains are taxed from the disposition of United States Real Property Interests (“U.S.R.P.I.’s”). The law has a fairly extensive definition of U.S. real property for this purpose. Most significantly, the law provides for a withholding mechanism in most cases.

WHAT IS A U.S.R.P.I.?

A U.S.R.P.I. includes the following:

  • Land, buildings, and other improvements;
  • Growing crops and timber, mines, wells, and other natural deposits (but not severed or extracted products of the land);
  • Tangible personal property associated with the use, improvement, and operation of real property such as:
    • Mining equipment used to extract deposits from the ground,
    • Farm machinery and draft animals on a farm,
    • Equipment used in the growing and cutting of timber,
    • Equipment used to prepare land and carry out construction, and
    • Furniture in lodging facilities and offices.

  • Direct or indirect rights to share in appreciation in value, gross or net proceeds, or profits from real property;
  • Ownership interests other than an interest solely as a creditor, including:
    • Fee ownership;
    • Co-ownership;
    • Leasehold interest in real property;
    • Time-sharing interest;
    • Life estate, remainder, or reversionary interest; and
    • Options, contracts, or rights of first refusal.

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property - Part I

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INTRODUCTION

U.S. real estate has been a popular choice for foreign investors, whether the property is held for personal use, rental or sale, or long-term investment. Since the passage of the Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”), the governing tax rules have developed and evolved, but have not succeeded in discouraging foreign investment. F.I.R.P.T.A. can be a potential minefield for those unfamiliar with U.S. income, estate, and gift taxation – all of which come into play. This article is the first of a series on understanding U.S. taxation of foreign investment in real property.

TAXATION OF A FOREIGN PERSON

“A foreign person is subject to U.S. income tax only on income that is characterized as U.S. source income.”

As simple as the concept sounds, there are applicable nuances, caveats, exemptions, and exceptions. Therefore, several questions must first be answered to determine the U.S. income tax consequences for a foreign person engaged in U.S. economic activities, including ownership of real property:

  1. Is the income derived from a U.S. source and therefore potentially taxable?
  2. Is the income taxable or exempt from tax?
  3. Is the income passive or active, subject to a flat withholding tax on gross income or, alternatively, to graduated rates on net income?
  4. Is the income earned by an individual or corporation or other entity, each of which may have different rules and applicable tax rates?

Tax 101: Tax Planning and Compliance for Foreign Businesses with U.S. Activity

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I. INTRODUCTION

The U.S. tax laws affecting foreign businesses with activity in the U.S. contain some of the more complex provisions of the Internal Revenue Code. Examples include:

  • Effectively connected income,
  • Allocation of expenses to that income,
  • Income tax treaties,
  • Arm’s length transfer pricing rules,
  • Permanent establishments under income tax treaties,
  • Limitation on benefits provisions in income tax treaties that are designed to prevent “treaty shopping,”
  • State tax apportionment,
  • F.I.R.P.T.A. withholding tax for transactions categorized as real property transfers,
  • Fixed and determinable annual and periodical income, and
  • Interest on items of portfolio debt.

One can imagine that it is no easy task to identify income that is subject to tax, to identify the tax regime applicable to the income, and to quantify gross income, net income, and income subject to withholding tax. Nonetheless, the I.R.S. has identified withholding tax obligations of U.S. payers as a Tier I audit issue.

Home Thoughts From Abroad: Foreign Purchases of U.S. Homes

Published in TAX NOTES Tax Analysts Special Report, September 2007.

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