Let’s say a foreign corporation owns a building in the United States that houses a restaurant. Suppose the corporation owns everything, including the land, the building and the furnishings. If the company sells the entire asset, would it pay taxes on the furniture, all those tables, chairs and barstools?
Questions like this—we’ll answer it later—make it clear there is much to learn about the Foreign Investment in Real Property Tax Act (FIRPTA) and how it is applied when selling investment properties. Understanding how gains and losses are taxed is foundational to proper tax planning, and we’ll cover some of the basics here.
What is ‘Real Property Interest?’
Let’s start with this: FIRPTA taxes apply when a foreign investor or a foreign corporation sells a United States Real Property Interest. What is that? The law says it is one of two things: A real piece of property in the United States or the U.S. Virgin Islands or stock in a United States Real Property Holding Corporation.
Real property is defined broadly. It could be land or buildings. But it can also be a well or a mine. It includes fee ownership, co-ownership, lease holds and options. And yes, it also includes associated personal property such as furnishings. There’s the answer to our question above. If the company sells the restaurant, it will be subject to FIRPTA taxes on the land, the building and the furniture. There are some exceptions, but it gets complicated and its best to consult a tax advisor who can explain it in detail.
What is a Real Property Holding Corporation?
A United States Real Property Holding Corporation is a domestic corporation that holds U.S. property interests as the majority of its assets. If these properties are 50 percent or more of its overall assets, then the corporation is considered a United States Real Property Holding Corporation for tax purposes.
If a foreign investor or a foreign corporation sold stock in that entity, it would be considered a U.S. Real Property Interest and subject to FIRPTA taxes and withholding.
However, there are some exceptions. For example, if the corporation did not meet the 50 percent threshold for five years before the stock is sold, then it is not considered a U.S. Real Property Interest and will not be subject to FIRPTA tax.
‘Blocker’ Corporations and Strategies
With careful tax planning and deal structure, FIRPTA taxes can be mitigated. One strategy is to use the U.S. Real Property Holding Corporation as a “blocker.” In this strategy, the corporation sells the U.S. property, rather than the foreign investors or companies who are shareholders selling stock. The corporation is then liable to pay the FIRPTA taxes, rather than the shareholders.
In a more sophisticated version of this strategy, a parent corporation might own a subsidiary, and that subsidiary owns U.S. property. If the parent company owns 100 percent of the subsidiary’s stock, then the parent would be considered a U.S. Real Property Holding Corporation. Shareholders would be subject to FIRPTA taxes when they sell stock.
However, if the parent company holds less than a controlling interest in that subsidiary, say, for example, 49 percent, then the parent would not be considered a U.S. Real Property Holding Corporation. Foreign investors and corporations who are shareholders would not be subject to FIRPTA taxes when they sell stock.
What happens when the foreign investor is a pass-through entity like a partnership, trust or estate? Are these types of companies subject to FIRPTA tax when they sell U.S. property interests?
No. The pass-through itself is not subject to taxes. Rather, the tax system treats the partners or beneficiaries as the owners of the property, whether it is an actual real estate holding or stock in a U.S. Real Property Holding Corporation. When the property or stock is sold, each partner (whether they are foreign investors or foreign corporations) is liable for their proportionate share of the FIRPTA taxes.
For example, let’s say that a foreign investor and a foreign corporation each own 50 percent of a partnership, and that partnership owns a hotel in the United States. When the hotel is sold, the partnership itself would not be liable for FIRPTA taxes. Instead, the investor and the corporation would each receive 50 percent of the gain from the sale and would be subject to 50 percent of the FIRPTA taxes on that gain.
Obviously, it is important to understand how sales-related gains are treated by FIRPTA when selling investment properties. The rules can get complicated. How property is defined, who owns it and the structure and percentage of that ownership can matter greatly. The need for proper tax planning and professional advice becomes clear. To learn more, 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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