Real Estate Tax Alert

FIRPTA reform passes Senate Finance Committee The Senate Finance Committee recently passed certain changes to the Foreign Investment in Real Property Tax Act (FIRPTA) which generally subjects non-US persons to tax on sales of United States real property interests. The bill was passed unanimously, evidencing bipartisan support. While this is an important step in the legislative process, the bill would need to be passed by both Houses of Congress and signed into law by the president before it became effective.

Increased investment opportunities for non-US investors in publicly traded REITs If the bill were to become law, one beneficiary would be publicly traded REITs as it would allow them to more easily attract foreign capital. Under current law, FIRPTA can cause non-US investors to be subject to US taxes with respect to certain sales of REIT stock and certain distributions from REITs. Often the FIRPTA taxes can be more than the taxes that would be owed if the foreign investor had invested in other publicly traded non-real estate companies. In addition, if a foreign investor is subject to FIRPTA, generally the foreign investor would be required to file a US federal income tax return. An exemption from FIRPTA currently applies with respect to investments in publicly traded companies if the foreign investor owns 5% or less of the company’s stock. The bill would increase the limit from 5% to 10% for publicly traded REITs. In addition, the bill provides that interests in publicly traded REITs held by publicly traded “qualified collective investment vehicles” would also be exempt from FIRPTA. To be eligible for the exemption, among other things, the investor must be eligible for a reduced rate of withholding under a comprehensive income tax treaty which includes an exchange of information program and would also be required to maintain certain information on the identity of its owners.

New rules and presumptions for domestically controlled REIT status The bill would provide some new rules and presumptions regarding the determination of whether a REIT is a domestically controlled REIT. Under current law, the sale of stock of a domestically controlled REIT is not subject to FIRPTA. A domestically controlled REIT generally is a REIT, less than 50% of the stock of which is held by foreign persons. The bill provides that publicly traded REITs listed on a US exchange will be able to treat their shareholders that hold less than 5% of their stock as US persons, except to the extent the REIT has actual knowledge that such shareholders are non-US persons. If this bill passes, this would be welcome news for public REITs which often

believe they are domestically controlled, but are unable to confirm this due to their lack of insight regarding the individual owners of their stock. The bill also provides some rules related to the treatment of REITs that are shareholders in other REITs for purposes of determining if the lower-tier REITs are domestically controlled. First, a publicly traded REIT that itself is a domestically controlled REIT would be treated as a US person in whole (even if it did have some foreign shareholders). Second, a publicly traded REIT that is not a domestically controlled REIT would be treated as a non-US person in whole (even though the shareholder REIT is, itself, a US person and even if the shareholder REIT did have some US shareholders). Finally, a non-publicly traded REIT would be treated as a US person only to the extent that the stock of the non-publicly traded REIT was held by US persons.

Increased enforcement of current FIRPTA tax rules In addition, there were several offsets that were intended to raise additional revenue to pay for the items noted above. Several of these offsets are not changes to the substantive FIRPTA tax rules, but change the rules regarding FIRPTA withholding to increase the taxes that are actually collected by improving compliance with FIRPTA. First, the rate of withholding on FIRPTA generally would increase from 10% to 15%. Note that this is not an increase in the substantive FIRPTA tax, but an increase in the withholding that would be required by a purchaser in connection with the acquisition of real property from a non-US person. The withholding would generally offset any tax actually due from the non-US person on the sale and would be eligible for refund to the extent the substantive tax was less than the amount withheld. One aspect of the bill that deserves the particular attention is a new provision that would require public disclosure regarding whether the entity is treated as a United States real property holding corporation (USRPHC). The proposal is interesting in that it requires disclosure not only on the entity’s tax return and Forms 1099, but in various other places such as the entity’s website, annual reports and stock certificates. The final legislative language will need to be reviewed to determine how burdensome it may be to provide such disclosures, where the disclosures will need to be made, and how changes in the USRPHC status of an entity should be taken into account. A severe penalty of at least $500,000, increasing to $5 million ($10 million for an intentional failure to report), based on the gross fair market value of the corporation’s assets, is provided for failures to meet the disclosure requirement and should garner the attention of those tasked with tax compliance at various companies. This penalty seems extraordinarily high for failure failing to satisfy an administrative requirement. In another effort to increase compliance with the current FIRPTA regime, brokers would now be required to withhold a portion of the sales proceeds on the sale of interests in corporations, the sale of stock of which would be subject to FIRPTA. Again, this provision does not increase the FIRPTA tax owed, but puts additional rules in place to increase the likelihood that current taxes imposed under FIRPTA are collected.

Other revenue offsets Under current rules, if an interest in a corporation would be subject to FIRPTA if sold, the corporation could cleanse its FIRPTA taint if the corporation liquidates after selling all of its US real property interest in taxable transactions. The bill would provide that any corporation that was a REIT or a RIC in the prior five years would not be able to cleanse its FIRPTA status in this manner.

Real Estate Alert | February 2015

2

Finally, for purposes of determining whether dividends from a foreign corporation (attributable to dividends from an 80-percent owned domestic corporation) are eligible for a dividends-received deduction under section 245 of the Code, dividends from RICs and REITs are not treated as dividends from domestic corporations.

Other FIRPTA proposals While several of the provisions noted above have been included in various FIRPTA reform proposals in the past, it is worth noting some of the FIRPTA reform proposals that have been advanced were not included in the bill discussed above. First, there have proposals to exempt foreign pension funds from FIRPTA to put them in a similar place to US pension funds. While this provision was not included in the bill that was passed by the Senate Finance Committee, it was subject to extensive discussion during the debate on the bill. There seemed to be an appetite among the Senators to include such a provision in the bill as it works its way to becoming legislation. Second, there have been proposals to effectively repeal part of IRS Notice 2007-55. This notice provided that, among other things, a liquidating distribution by a REIT would be subject to tax as a distribution by the REIT and would not be treated as a sale of stock (which is how liquidating distributions are generally treated under US income tax rules). This provision was not included in the bill discussed above and, although the opportunity to add such a provision may be possible in the future, there was no positive indication that such a provision was likely to be included as this bill advances through the Congress.

For additional information concerning this issue, please contact: Adam Feuerstein 703-918-6802 [email protected]

Real Estate Alert | February 2015

3

PwC Real Estate Tax Practice – National and Regional Contacts: National David Voss US RE Tax Leader New York 646-471-7462 [email protected] Regional Atlanta Dennis Goginsky 678-419-8528 [email protected] Chris Nicholaou 678-419-1388 [email protected] Steve Tyler 678-419-1224 [email protected] Boston Timothy Egan 617-530-7120 [email protected] Rachel Kelly 617-530-7208 [email protected] John Sheehan 646-471-6206 [email protected] Chicago Jill Loftus 312-298-3294 [email protected] Alan Naragon 312-298-3228 [email protected]

Los Angeles

New York cont.

Adam Handler 213-356-6499 [email protected]

Oliver Reichel 646-471-5673 [email protected]

Phil Sutton 213-830-8245 [email protected] Miranda Tse 213-356-6032 [email protected] New York Eugene Chan 646-471-0240 [email protected] Dan Crowley 646-471-5123 [email protected] James Guiry 646-471-3620 [email protected] Sean Kanousis 646-471-4858 [email protected] Christine Lattanzio 646-471-8463 [email protected]

Dallas

David Leavitt 646-471-6776 [email protected]

William Atkiels 214-754-5388 [email protected]

Marina Levin 646-471-6035 [email protected]

Paul Ryan 646-471-8419 [email protected] San Francisco Kevin Nishioka 415-498-7086 [email protected] Neil Rosenberg 415-498-6222 [email protected] Washington DC Karen Bowles 703-918-1576 [email protected] Adam Feuerstein 703-918-6802 [email protected] Laura Hewitt 617-530-5331 [email protected] Kelly Nobis 703-918-3104 [email protected]

James Oswald 646-471-4671 [email protected]

Real Estate Alert | February 2015

4

www.pwc.com/us/assetmanagement

© 2015 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. Solicitation