FIRPTA taxes apply when foreign investors or property investment companies sell U.S. real estate assets. But what about distributions, liquidations and other transactions?
A complicated system of FIRPTA rules apply to these situations and it is important to understand how these rules apply before structuring transactions. We’ll discuss some of the more common cases.
Generally speaking, a foreign corporation must realize a gain to be subject to FIRPTA tax, and that includes distributions, whether as part of a liquidation or to redeem a shareholder’s interest in the corporation. The taxable portion of the transaction will be the asset’s fair market value, minus the tax basis (usually the amount that was paid to acquire it).
Distributions and Exemptions
For example, if the fair market value of a real estate asset is $10 million and the tax basis is $4 million, and the foreign corporation distributes the asset to a shareholder to redeem their interest in the corporation, the corporation would recognize a gain of $6 million and that money would be subject to FIRPTA taxes.
There are some important exceptions. If the person or company receiving the distribution would be subject to FIRPTA tax upon selling the asset, the corporation may not be subject to FIRPTA taxes.
For example, let’s assume that a foreign corporation owns 100 percent of the stock in a subsidiary corporation, and that subsidiary owns U.S. real estate assets. If the subsidiary liquidates and transfers all the real estate assets to the parent corporation, the tax basis on those assets conveys with them. The corporation would be subject to FIRPTA taxes when it sells the real estate assets. The subsidiary would not be subject to FIRPTA taxes when it made the distribution.
Pass-Throughs and Capital Transfers
What about pass-through entities like partnerships or limited liability corporations? When these property investment companies sell U.S. real estate assets, the foreign investors or corporations with a partnership stake are subject to FIRPTA tax. The amount of tax they pay is based on their percentage of ownership in the passthrough entitties gain.
The same concept applies if foreign investors or corporations sell their stake in a pass-through entity such as a partnership or trust.
What happens when a foreign investor or a foreign corporation transfers a U.S. real estate asset to another foreign corporation? The transaction is treated like a sale, and the seller is generally subject to FIRPTA taxes on the gain. As described above, this means the amount by which the market value exceeds the tax basis.
As a rule, a person who transfers U.S. real estate to a foreign corporation is treated as having sold that property for tax purposes, under the theory that the asset has been transferred offshore and will henceforth be beyond the reach of the U.S. tax system. This is often called a “toll charge.” The taxes are the toll for moving the property offshore.
While the details of every transaction will be different, it is clear that FIRPTA taxes extend to transactions beyond simple sales, and that means property investment companies should understand the tax consequences of an investment before contracts are signed and money or assets change hands. To learn more and FIRPTA law and its applications, download our guide, Taxation of Foreign Investments in U.S. Real Estate. It’s free and provides a complete primer on the basics of FIRPTA law.
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