Impact of the PATH Act on FIRPTA
On December 18, 2015, Congress passed and President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act” or the “Act”), enacting several changes to the Foreign Investment in Real Property Tax Act (“FIRPTA”). This particular post highlights the new interplay of the PATH Act and FIRPTA.
Publicly Traded REITs:
Generally, gain derived from the disposition of stock in a “foreign-controlled” publicly traded REIT (i.e., a REIT more than 50% owned by foreign person during the testing period) is subject to FIRPTA. Naturally, a determination if a REIT is foreign controlled or domestic is potentially difficult if underlying shareholder information is not readily available. The PATH Act addresses the issue in 2 ways. First, the PATH Act simplifies the process for determining whether a REIT is foreign-controlled, and subject to FIRPTA, by creating a presumption that any shareholder owning less than 5% of the REIT is a U.S. person unless the REIT has knowledge to the contrary. Second, the PATH Act modifies an exemption allowing foreign persons to own up to 5% of a publicly traded REIT without triggering FIRPTA, by raising this threshold ownership percentage from 5% to 10%. Accordingly, a foreign person may now hold up to 10% of a publicly traded REIT, domestic or foreign, without being subject to FIRPTA on the sale of the REIT stock. Consequently, any distribution from a publicly traded REIT to a foreign person owning less than 10% of the REIT is treated as a dividend rather than ECI under FIRPTA.
This change is in effect for dispositions and distributions on or after December 18, 2015.
Under the PATH Act, qualified foreign pension plans will no longer be subject to FIRPTA on gain from the sale or disposition of U.S. real property interests (“USRPI”) held through a partnership, or on capital gains distributions received from a REIT attributable to such dispositions. The PATH Act essentially places foreign and domestic funds on equal footing.
This change is in effective for disposition and distributions on or after December 19, 2015.
Withholding on FIRPTA Distributions:
Another significant change to FIRPTA involves the 10% withholding tax rate imposed on gross proceeds from sales. The PATH Act increases the rate on FIRPTA withholding from 10% to 15%. Readers should note that original 10% withholding rate remains in effect where the transferee acquires a personal residence and the purchase price does not exceed $1 million.
This change is in effect for dispositions occurring 60 days after December 15, 2015.
Elimination of the “Cleansing Rule” for RICs and REITs
The PATH Act alters the FIRPTA “cleansing rule.” The pre-PATH “cleansing rule” provided that an interest in a corporation was not U.S. real property interest if, as of the date of disposition, the corporation owned no USRPIs and all USRPIs held by said corporation during the testing period were disposed of in transactions in which the full gain was subject to U.S. tax.
Under the PATH Act, the cleansing rule does not apply to any USRPHC that was a RIC or REIT at any time during the relevant testing period. This change applies to dispositions on or after December 18, 2015.