Transactions Beyond the Reach of FIRPTA Tax

  |  March 8, 2018

We write a great deal about the transactions that are subject to taxation under the Foreign Investment in Real Property Tax Act (FIRPTA). But what about the transactions that are not subject to FIRPTA tax?

Indeed, there are many. There are exemptions in the U.S. tax code that can allow a foreign investor or foreign company to structure transactions without paying FIRPTA tax. To do so will require guidance from an experienced tax advisor, and it won’t hurt if you have a working knowledge of FIRPTA exemptions. Let’s discuss some basics.

Understanding ‘Nonrecognition Provisions’

The U.S tax code allows for property to be exchanged in certain cases without the companies involved in the exchange generating any taxable gain. Examples include tax free reorganizations and certain liquidations of wholly owned subsidiaries into parent corporations. These nonrecognition provisions assume that deferred gain eventually will be taxed when the property is sold.

For example, let’s assume that a foreign company owns a U.S. resort, and it decides to take on an additional investor in order to expand. A new LLC is formed and the foreign company contributes the resort to the LLC. The investor contributes capital for the expansion. The foreign company will not be subject to FIRPTA tax when contributing the resort. Rather, it will pay FIRPTA taxes when the LLC sells the property.

Here’s another one: A foreign company owns a hotel in Laguna Beach, California. It swaps the hotel in Laguna for a hotel in New York City. The transaction is a like kind exchange and is not a taxable event under FIRPTA until the company sells the hotel in New York.

Public and Private REITS

Foreign investors who do not own more than 10 percent of a publicly traded REIT are not subject to FIRPTA tax on capital gain dividends or the sale of REIT stock. With respect to the dividends, they are subject to 30% U.S. withholding tax unless reduced by a treaty provision.

If a private REIT is domestically controlled, the foreign investor is not subject to FIRPTA tax on the sale of its shares. To qualify as a domestically controlled REIT, more than 50% of the capital and voting control must be owned by US persons for the shorter of 5 years from the date of sale or the inception of the REIT. If the REIT sells the real estate, the foreign investors share of gain flows through to the foreign investor and they are subject to FIRPTA tax.