United States: Protecting Americans From Tax Hikes Act Of 2015: Effects On Taxation Of Investment In US Real Estate

Keywords: Protecting Americans from Tax Hikes Act 2015, Foreign Investment in Real Property Tax Act 1980, FIRPTA, withholding tax, real estate investment trusts,

On December 18, 2015, Congress passed and President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the "Act"). The Act provides exemptions from certain taxes applicable to non-US investors in US real estate under the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"), increases the FIRPTA withholding tax rate and modifies certain rules relating to real estate investment trusts ("REITs").

FIRPTA Provisions

Under FIRPTA, non-US investors in US real estate (including investments in REITs and other US companies for which 50 percent or more of the company's assets are US real estate assets) are generally subject to US federal income tax in the same manner as US investors on sales of such US real property interests ("USRPIs"). The Act makes a number of changes to FIRPTA that will be very significant to certain classes of non-US investors.

New Exemption from FIRPTA for Certain "Qualified Foreign Pension Plans"

A new exemption from FIRPTA ("Pension Exemption") is provided for "qualified foreign pension funds" and entities wholly owned by qualified foreign pension funds. A qualified foreign pension fund is an entity that (i) is organized under the laws of a foreign country, (ii) is established to provide retirement or pension benefits to current or former employees, (iii) does not have a single beneficiary with a right to more than 5 percent of its assets or income, (iv) is subject to government regulation and reporting requirements regarding its beneficiaries and (v) is subject to deferred or reduced taxation in its home country. This new exception from FIRPTA for qualified foreign pension funds could significantly increase the amount that non-US pension funds invest in US real estate.We note that the Internal Revenue Service ("IRS") was given authority to promulgate regulations as may be necessary or appropriate to carry out the purposes of this new Pension Exemption. The timing and content of any such regulations is currently uncertain.

Increase in Exception for Small Interests in Publicly Traded REITs

Under prior law, FIRPTA did not apply to non- US investors holding 5 percent or less of a class of publicly traded stock of a US real property holding corporation (including a public REIT). The Act increases the threshold for this small interest exception to 10 percent in the case of publicly traded REITs (but not for other types of US real property holding corporations). Accordingly, a non-US shareholder of publicly traded REIT stock that does not own more than 10 percent of such class of stock will not be subject to US tax under FIRPTA when selling or receiving capital gain distributions on that stock. However, capital gain distributions on such REIT stock will be treated as ordinary dividends from the REIT, and potentially be subject to dividend withholding.

New Exceptions for Qualified Foreign Shareholders of REITs

The Act provides a new exception from FIRPTA for REIT stock (including stock of a privately held non-domestically controlled REIT) held by a "qualified shareholder." A qualified shareholder is defined as a foreign person that is either (i) eligible for benefits under a comprehensive US tax treaty and listed and regularly traded on one or more recognized stock exchanges (as defined in the relevant treaty) or (ii) a foreign limited partnership that (A) is organized in a jurisdiction that has an exchange of information agreement with the United States, (B) has a class of interests (representing more than 50 percent of the value of all partnership interests) that is regularly traded on the NYSE or NASDAQ market, (C) is a qualified collective investment vehicle (which requires the entity to satisfy certain additional requirements) and (D) maintains records on the identity of each person that directly holds 5 percent or more of certain classes of interest in the entity.

Qualified shareholder treatment does not apply with respect to the portion of the REIT interest attributable to an "applicable investor" (generally an investor in the qualified shareholder that directly or indirectly owns a more than 10 percent interest in the REIT). Moreover, REIT capital gain distributions to qualified shareholders, although excluded from withholding under FIRPTA, will instead be treated as ordinary dividends from the REIT. The qualified shareholder rule is likely to provide significant benefits for foreign publicly traded companies, property trusts and other investment vehicles that satisfy the requirements for qualified shareholder status.

Elimination of "Cleansing Rule" for RICs and REITs

Under prior law, stock in a corporation would not be deemed a USRPI if (i) the corporation did not hold any USRPIs and (ii) any USRPIs held by it during the shorter of the shareholder's ownership period or five years had been disposed of in fully taxable transactions. The Act modifies this rule this by adding a third requirement: that the liquidating corporation was not a REIT or regulated investment company ("RIC") during the shorter of the shareholder's ownership period or five years. This prevents foreign investors from avoiding FIRPTA withholding by having a REIT sell its property and then liquidate, which would meet the literal requirements of the cleansing rule while potentially avoiding both entity-level and foreign shareholder-level tax.

Look-Through Rule Changes Testing for Domestically Controlled REIT Status

A non-US investor is subject to tax under FIRPTA on any gain recognized from the disposition of an interest in a REIT that constitutes a US real property holding corporation, unless the REIT is "domestically controlled," or certain other exemptions apply. A REIT is "domestically controlled" if less than 50 percent of the value of its stock is held, directly or indirectly, by non-US investors. The Act provides that in applying this test, all holders of less than 5 percent of any class of publicly traded REIT stock are treated as US persons unless the REIT has actual knowledge that a holder is not a US person. The Act also provides that stock in a REIT held by a publicly traded REIT will be treated as held by a foreign person unless the shareholder REIT is itself domestically controlled. These rules simplify the application of domestically controlled testing for public REITs and for private REITs that have a public REIT as a direct or indirect shareholder. For REIT stock held by a private REIT, however, the Act provides a look-through rule treating such stock as held by a US person only to the extent that the stock of the shareholder REIT is held by US persons.

Increase in FIRPTA Withholding Tax Rate

Finally, the Act increases the rate of withholding required under FIRPTA from 10 to 15 percent of a foreign seller's gross proceeds from the disposition of a USRPI. This provision will affect sales taking place more than 60 days after the enactment of the Act.

New Restrictions on Tax-Free Spinoffs Involving REITs

The Act's most publicized change relates to the treatment of tax-free spinoffs involving REITs under Section 355 of the Internal Revenue Code (the "Code"). The modified Section 355 generally states that a spinoff involving a REIT will be tax free only if, immediately after the transaction, both the distributing and controlled corporations are REITs or if an existing REIT is distributing stock in a taxable REIT subsidiary ("TRS"). The Act also modifies Section 856(c) so that neither the distributing nor the controlled corporation can elect to be treated as a REIT for 10 years after a spinoff. These changes likely put an end to a recent wave of REIT spinoffs, although transactions for which a ruling request has been submitted to the IRS prior to December 7, 2015 are grandfathered in and protected from changes to the law.

REIT Asset Test Changes

The Act makes several modifications to the 75 percent REIT asset test. First, it reduces the percentage of the gross asset value of a REIT's assets that may be represented by securities of one or more TRSs from 25 percent to 20 percent. It also expands the definition of real property for purposes of the 75 percent asset test to include certain ancillary personal property leased with real property and debt instruments issued by publicly traded REITs. It should be noted that debt instruments of publicly traded REITs may not make up more than 25 percent of the value of a REIT's assets.

REIT Income Test Changes

Not surprisingly, the Act also addresses the income tests described in paragraphs (2) and (3) of Section 856(c). Income from debt instruments issued by publicly traded REITs is now treated as qualified income for purposes of the 95 percent gross income test. Such income is not, however, treated as qualified income for purposes of the 75 percent gross income test unless the income from such debt instruments was already treated as qualified income under current law.

The Act also expands the treatment of REIT hedges by permitting REITs to use a hedging instrument to terminate a prior hedging instrument that was used to manage risk associated with liabilities or property, without gain from such transaction constituting gross income for purposes of the 95 percent gross income test or the 75 percent gross income test.

REIT Dividends

Multiple sections of the Act relate to REIT dividends. Most notably, the Act repeals the preferential dividend rule for publicly traded REITs. It also allows the IRS to provide an "appropriate remedy" for a preferential dividend distribution by a non-publicly traded REIT in lieu of treating the dividend as not qualifying for the REIT dividends-paid deduction, provided that the preferential distribution is inadvertent or due to reasonable cause and not due to willful neglect. Finally, the Act limits the aggregate amount of dividends that may be designated by a REIT as qualified dividends or capital gain dividends to the amount of dividends actually paid by the REIT and revises the calculation of current REIT earnings and profits for purposes of determining whether REIT shareholders are taxed as receiving a REIT dividend or as receiving a return of capital (or capital gain if a distribution exceeds a shareholder's stock basis).

REIT Income Excluded from Favorable Foreign Dividend Treatment

Generally, dividends received from a foreign corporation by a 10 percent domestic shareholder are not eligible for the dividends received deduction, except to the extent of the "US-source portion" of such dividends. The Act excludes income from a REIT from the US-source portion of such a dividend. As a result, if a domestic REIT pays a dividend to a foreign parent, and the foreign parent pays a dividend to its domestic parent, the domestic parent will not be able to use the dividends received deduction with respect to the portion of income attributable to the domestic REIT.

Safe Harbors and Taxable REIT Subsidiaries

Section 857(b)(6)(A) imposes a 100 percent tax on the net income derived from "prohibited transactions," defined as the sale or other disposition of inventory property or property held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business. Section 857(b)(6)(C) provides a safe harbor under which the sale of real property will not be treated as a prohibited transaction if certain requirements are met. The Act expands the safe harbor by providing for a three-year averaging method for determining the percentage of assets that a REIT may sell annually and by allowing REITs to have TRSs develop and market REIT real property without subjecting the REIT to the 100 percent prohibited transactions tax. The Act makes clear that the 100 percent excise tax on non-arm's length transactions applies to services provided by a TRS to its parent REIT.

Permanent Reduction of REIT Built-in Gains Recognition Period

The Act permanently extends the rule reducing from 10 years to five years the period for which an S corporation must hold its assets after conversion from a C corporation to an S corporation in order to avoid corporate tax on built-in gains. Because the REIT built-in gains provision cross-references the S corporation built-in gains tax provision, this change also applies to REITs that have undertaken conversion transactions or acquired assets from C corporations in certain nonrecognition transactions. This change may be very significant to REITs that hold former C corporation assets and to C corporations contemplating REIT conversions. The provision applies to tax years beginning after December 31, 2014.

Originally published 21 December 2015

Learn more about our Tax and Real Estate practices.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2015. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Cadwalader, Wickersham & Taft LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Cadwalader, Wickersham & Taft LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions