PATH Act Encourages Foreign Investment in U.S. Real Estate

The new Protecting Americans from Tax Hikes Act of 2015 (PATH Act) aims to promote the growth of the U.S. economy and provide tax relief to U.S. taxpayers. Foreign investors stand to benefit as well.

While most of the PATH Act discussion has centered around the permanent extension of several tax provisions benefiting U.S. taxpayers, the new law also includes significant changes designed to encourage foreign investment in U.S. real estate.

The United States imposes a special tax regime on foreign investment in U.S. real estate by way of the Foreign Investment in Real Property Act of 1980 (FIRPTA). Essentially, FIRPTA imposes an income tax on the gain generated when a foreigner sells U.S. real estate.

In these transactions, the buyer is required to withhold 10% of the sales proceeds and remit it to the Internal Revenue Service (IRS). The foreign seller is then required to file an income tax return to report the sale and either: a) pay additional tax if the 10% withheld was not sufficient to cover the ultimate tax liability, or b) request a refund if the 10% withholding exceeded the ultimate tax liability.

Foreign pension funds now exempt from FIRPTA

The PATH Act contains multiple provisions intended to promote foreign investment in the U.S.

The first of these provisions, and perhaps the biggest change, completely exempts qualified foreign pension funds from FIRPTA. With this change, a “qualified foreign pension fund” will no longer be subject to the FIRPTA withholding requirement upon the sale of real estate, nor will it be liable for any U.S. income tax upon such sale.

A qualified foreign pension fund includes any trust, corporation, or other organization or arrangement that meets the following criteria:

• is created or organized outside the United States,
• is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees of one or more employers in consideration for services rendered,
• does not have a single participant or beneficiary with a right to more than 5% of its assets or income,
• is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the home country, and
• contributions which would otherwise be subject to tax under the home country laws are deductible or excluded from the gross income of the entity or taxed at a reduced rate, or b) taxation of any investment income is deferred or that income is taxed at a reduced rate.

PATH Act relaxes REIT rules under FIRPTA

Another provision that aims to encourage investment in U.S. real estate is the relaxation of the FIRPTA provisions as they relate to a real estate investment trust (REIT). A REIT is essentially a domestic entity that owns and operates income-producing U.S. real estate and that must adhere to certain tax requirements.

There are various provisions affecting REITs under the PATH Act, but probably the most notable is expanding the publicly traded exception to FIRPTA. Under the general FIRPTA provisions, a foreign owner who sells an ownership interest in a domestic entity (including a REIT) is subject to the FIRPTA provisions if the majority of its assets consist of U.S. real estate.

Previously there was an exception to the FIRPTA provisions for foreign owners who owned less than 5% of the stock of such an entity, including a REIT. The PATH Act increases to 10% the maximum ownership that a foreigner can have in a publicly traded REIT and still qualify for the FIRPTA exemption.

FIRPTA withholding rate increased

It is important to note that the lost revenue from the aforementioned changes is being partially offset by increasing the FIRPTA withholding rate that applies when a foreigner sells U.S. real estate. For transactions occurring on or after February 17, 2016, the FIRPTA withholding rate will be increased from 10% to 15%. The existing 10% FIRPTA withholding rate will continue to apply in transactions where a purchaser acquires a personal residence and the purchase price does not exceed $1 million.

The PATH Act includes a myriad of changes to U.S. tax law that will primarily benefit U.S. taxpayers.  However, there are various tax provisions that will also benefit and encourage foreign investors – specifically those investing in U.S. real estate. This may be especially true in South Florida’s real estate market, which has seen high rates of foreign investment in recent years, and will likely see even more now that these FIRPTA requirements have been eased.

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Carlos A. Somoza, J.D., LL.M., is an international tax principal in Kaufman Rossin’s Miami office. Kaufman Rossin is one of the top accounting firms in the U.S. Carlos can be reached at csomoza@kaufmanrossin.com.