Changes to FIRPTA under the PATH Act

Volume No. US-16-01

On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “Act” or the “PATH Act”). The PATH Act, in part, modified the application of the Foreign Investment in Real Property Tax Act of 1980 (commonly referred to as FIRPTA).

 

In general, the term “United State real property interest (USRPI)” means an interest in real property located in the U.S. and any interest in a United States real property holding corporation (USRPHC). The gain or loss from the disposition of such an interest, by a foreign person, is treated as if the gain or loss were effectively connected with the conduct of a U.S. trade or business. Income effectively connected with a U.S. trade or business (known as ECI) is taxed at graduated rates.  Long term capital gains, assets held longer than 1 year, that are ECI are taxed at a maximum rate of 20%.

 

IRC §1445 provides rules for determining the withholding tax applicable to dispositions of a USRPI by a foreign seller.  Generally, the transferee (the purchaser) is required to deduct and withhold a tax equal to 10% of the amount realized on the disposition (in general, the selling price).   This is not a final tax but a withholding obligation on the purchaser to ensure that taxes are remitted to the IRS before the funds are distributed, out of the country, to the foreign seller.  The seller claims the credit (the amount withheld) as a credit when a subsequent U.S. tax return is filed.

 

Pursuant to IRC §897(c)(3), an interest in a publicly traded USRPHC is not a USRPI if the foreign person did not own more than 5% directly or indirectly during the five-year period ending on the date of disposition (the “Publicly Traded USRPHC Exception”).
Further, pursuant to IRC §897(h), any distribution by a qualified investment entity (QIE) (which includes  any real estate investment trust (REIT)), to a foreign shareholder, to the extent the distribution is attributable to gain from the sale or exchange of a USRPI,  be treated as gain recognized by the foreign shareholder as if it disposed the USRPI directly unless the distribution is from a publicly traded QIE and the foreign shareholder did not own more than 5% during the one-year period ending on the date of the distribution (the ‘Publicly Traded QIE Exception’).
Under the PATH Act, there are a number of other changes to the FIRPTA rules. The following are some, but not all of the changes to the FIRPTA rules:

  • An increase in the rate of withholding tax for dispositions subject to FIRPTA from 10 to 15 percent on dispositions of USRPIs, effective for dispositions occurring 60 days after the date of enactment (December 18th, 2015).   This will not have any impact on the seller’s ultimate tax liability but will have cash flow implications.
  • An increase in the current exemption from FIRPTA withholding tax on sales of property by non-U.S. persons to be used as residences by the buyers from $300,000 to $1.0 million. The provision applies to dispositions and distributions on or after the date of enactment.
  • An increase from 5 to 10 percent in the maximum stock ownership a shareholder may have held in a publicly traded stock to avoid having that stock treated under FIRPTA as a USRPI on disposition.
  • A new USRPI exception for stock held in a REIT by “qualified shareholders”. Stock of a REIT that is held by a qualified shareholder is not a USRPI unless there is an investor in the qualified shareholders who holds directly or indirectly more than 10% of the stock of such REIT. Distributions to a qualified shareholder by a REIT are not treated as gain from the sale or exchange of a USRPI and such distributions are treated as dividend. The provision applies to dispositions and distributions on or after the date of enactment
  • The PATH Act also made a number changes to U.S. REIT rules that effect investments in REIT by both U.S. and non-U.S. investors.

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The above  information is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of section 10.37(a)(2) of U.S. Treasury Department Circular 230. The contents of this document are intended for general information purposes only.