FIRPTA reforms are designed to spur investment from foreign investors by modernizing some exemptions of the law, making foreign investment into American real estate more appealing. On December 18, 2015, President Obama signed into the law the Act to extend certain tax relief provisions that were expiring at the end of 2014. The Bill was written to create legislative reforms to FIRPTA designed to bring in additional investment into a struggling marketplace.
There are a few major changes provided for in the reforms. The new Act exempts certain foreign pension funds and their subsidiaries from FIRPTA taxation. This will hopefully spur on more participation from these groups. It also increases the amount of Real Estate Investment Trust (REIT) stock participation that is available to foreign investors from 5 to 10 percent. The new rule creates a FIRPTA tax exemption for foreign investors upon the sale of a REIT stock or receipt of dividends. A third rule provides guidance on whether a REIT should be considered a domestically controlled entity. It allows REITs the ability to presume that all shareholders with less than a 5 percent stake in the REIT are U.S. citizens. The numbers can then be applied towards the 50% ownership mandate required for a REIT to be defined as “domestically controlled.”
Impact on U.S. Real Estate Investments
It is yet to be determined how the new rules will alter the commercial real estate investment landscape, yet the reform provisions being presented make it easier for foreign investors to participate in a more attractive market. With almost a quarter of all publically traded REIT’s in California alone, the impact in the western markets could be dramatic. Recent surveys show that nearly two-thirds of foreign real estate investors intend to increase their portfolio in 2016. Industry experts hope that the new rules will make those statistics a reality through offering higher after-tax returns from real estate investments than would be gained from other non-real estate or foreign investments.
While there has already been significant investment into the high-value office space markets such as New York, Chicago, and the like, indicators show that secondary market participation is picking up. Investors taking advantage of the new tax rules may be looking to hedge some of their office space assets with investments into non-traditional commercial real estate such as industrial buildings and rental housing.
As investment increases, the strategies for structuring investments will also evolve. Before the new reforms, investors would set up complicated U.S. corporate tax blockers to help defer tax liability incurred after sales of REIT stocks. These investment structures would often hinder the buying and selling of investments and ultimately increased the complexity of the investment process. Under the new rules, it may eliminate the need for these structures in some cases, making it far easier and more transparent for the foreign entity. The ability to freely buy and sell real estate investments without worry of overly burdensome tax liability, should in itself, be a boon to the commercial market.
The new reform actions are an indication of Congress’ continued dedication to spurring on U.S. investments. While the commercial real estate market is still recovering from the economic crunch of 2008, the new rules should offer clarity to an industry still seeking outside investment. With a market uptick already being seen in 2016, it is the hope of analysts that these new rules will provide accelerated growth and interest in U.S. commercial real estate investments.