Foreign Investment in Real Property Act (FIRPTA)

Foreign Investment in Real Property Act (FIRPTA)

September 18, 2023
Foreign Investment in Real Property Act (FIRPTA)
In general, a foreign person or corporation is not taxed on
owned by foreign investors. As a result, domestic REITs
U.S.-source capital gains income unless it is associated with
can be used for foreign investors to hold an interest in U.S.
operating a trade or business. However, under the Foreign
real property without being taxed.
Investment in Real Property Tax Act (FIRPTA), gain on the
sale of U.S. real property is taxed at the same rates that
Exemptions
apply to U.S. sellers. To ensure collection of this tax, the
Foreign governments and pension funds are exempt from
buyer is required to withhold part of the purchase price and
the FIRPTA tax.
submit a payment to the Internal Revenue Service, unless
the sale falls under one of several exceptions. The foreign
FIRPTA does not apply if (1) the investment is made
investor then files a U.S. tax return which can be used to
through a qualified investment entity; (2) the U.S. real
refund part of the withholding tax if it exceeds the tax on
property is regularly traded on an established U.S. securities
the gain.
market; and (3) the recipient foreign person or corporation
did not hold more than 5% of that class of stock or
The FIRPTA rules were adopted in 1980, as part of the
beneficial interest within the one-year period ending on the
Omnibus Reconciliation Act of 1980 (P.L. 96-499). The
date of distribution. (The American Jobs Creation Act of
general rationale was to equalize the tax treatment of
2004 [P.L. 108-357] extended the exception to cover capital
foreign and domestic investors, although it was also partly
gains distributions as well as stock sales.) A special rule
in response to concerns about purchases of U.S. farm land
adopted in the Protecting Americans from Tax Hikes
by foreign investors.
(PATH) Act of 2015, enacted as part of the Consolidated
Appropriations Act, 2016 (P.L. 114-113), increased the
FIRPTA Tax Rules
foreign ownership requirement to 10% for REITs.
FIRPTA rules treat the gain from the sale of real property
as effectively connected income associated with a U.S.
Sales that are eligible for nonrecognition under other rules,
business and thus subject to the same tax as a U.S. seller
such as corporate reorganizations and like-kind exchanges
(Section 897 of the Internal Revenue Code). Individuals are
(Section 1031), are generally treated the same under
taxed at capital gains tax rates (generally 15% and 20%)
FIRPTA. Taxes on gain are deferred until the property
and corporations at the corporate rate of 21%.
acquired in the exchange is sold. Section 1031 does not,
however, apply to the exchange of a U.S. property for a
The tax applies to real property located in the United States
foreign property.
and the Virgin Islands. The inclusion of the Virgin Islands
was to avoid, under the Virgin Island mirror tax code
FIRPTA Withholding Taxes
(which effectively applies U.S. tax rules to Virgin Islands
FIRPTA withholding taxes were enacted in the Deficit
residents), the use of a Virgin Islands corporation to avoid
Reduction Act of 1984 (P.L. 98-369). These rules require
the tax on gains on U.S. real property.
the purchaser of real property or interests in real property
from a foreign person to withhold taxes (Section 1445
The tax applies to direct holdings of real property and to
Internal Revenue Code). The PATH Act increased the
major holdings in certain U.S. real property holding
general FIRPTA withholding rate from 10% to 15% of the
corporations (USRPHC). A USRPHC is a corporation that
price of the property. This withholding is transmitted on
has 50% or more of its assets (real property plus assets used
IRS Form 8288 along with a withholding statement 8288-
in the trade or business) in U.S. real property. The most
A. The rules also require partnerships, estates, trusts,
common example of this type of corporation is a real estate
foreign corporations, and in some cases domestic
investment trust (REIT). REITs are corporations that issue
corporations to withhold tax on distributions of gain subject
shares of stock, are largely invested in real property, and do
to FIRPTA at the highest tax rate that would apply under
not generally pay corporate tax. REITs distribute and
the income tax.
deduct most income as dividends to shareholders.
Individual shareholders pay tax at ordinary individual
No withholding is required if the property is purchased by
income tax rates on those dividends (rather than the lower
an individual for use as a residence and the property is sold
rates normally applied to dividends on corporate stock).
for $300,000 or less. A lower withholding rate of 10%
REITs also distribute capital gains, which are taxed under
applies if the property is purchased for use as a residence
the capital gains tax, similarly to a partnership.
and is sold for $1 million or less.
The FIRPTA tax does not apply to USRPHCs that are
No withholding is required in several other circumstances,
REITs or regulated investment companies that are
including dispositions of stock in a publicly traded
domestically controlled, in that they are less than 50%
corporation and when affidavits are received indicating that
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Foreign Investment in Real Property Act (FIRPTA)
a privately traded corporation is not a USPRHC or that
would also include regular U.S. corporations if foreign
other arrangements have been made.
persons own 25% or more of the fair market value of stock.
One issue that may be encountered by purchasers of
Proposals and Issues
property of a foreign person is when the sale is part of a
In the 116th Congress, Representative Larson introduced a
Section 1031 like-kind exchange. In such cases, the
bill, H.R. 2210, to repeal FIRPTA. Also in the 116th
FIRPTA rules allow for the tax to be deferred. While the
Congress, Representative Suozzi introduced a bill, H.R.
tax could be recouped on a subsequent tax return, the seller
4598, to allow foreign insurance companies to be exempt
can submit an 8288-B (Application for Withholding
from FIRPTA. In the 117th Congress, Representative Suozzi
Certificate for Dispositions by Foreign Persons of U.S. Real
introduced a bill, H.R. 3123 , to allow nontraded publicly
Property Interests) in advance of the sale. The foreign
offered REITs the exemptions available to publicly traded
purchaser can also deposit the tax with the settlement agent
REITs.
and thereby be able to receive and reinvest the full purchase
price (thereby avoiding tax on the withholding amount that
The primary argument for eliminating FIRPTA, which the
would apply if it is not reinvested).
real estate industry has long advanced, is that it discourages
foreign investments in U.S. property, including
Revenue Effect
infrastructure property. The magnitude of such an effect is
In 2008, the Joint Tax Committee estimated the revenue
not known.
gain from FIRPTA was less than $50 million. This
provision was treated as a negative tax expenditure, that is,
As discussed in detail in a 2013 law review article by
a gain rather than a loss. FIRPTA has not subsequently
Professor Willard B. Taylor, a Treasury study prior to
been included in tax expenditure lists. Estimates of the
enactment of FIRPTA found that foreign ownership of land
revenue effects of revisions in the PATH Act indicate a
was insignificant. Treasury, however, was concerned about
larger pre-2015 amount, as the provisions increasing the
the different treatment of investors in business property
share of stock owned in REITs to 10% were projected to
who were able to avoid tax under the “effectively
lose about $100 million per year and the provision
connected” rule. Taylor points out that investment through
excluding pension funds was estimated to lose around $120
partnerships is typically subject to tax because the
million. The provision increasing the withholding rate on
partnership is involved in a trade or business. If just the
direct sales of property from 10% to 15% was much
FIRPTA rules affecting USRPHCs were eliminated, the tax
smaller, gaining about $20 million.
would still be imposed depending on the form of the
investment through a REIT or RIC (regulated investment
As noted below, one reason for the limited revenue
company) as compared to a partnership, so that some
collected from FIRPTA may be the ability to set up blocker
alternative rules (such as treating REITs the same as
corporations to create an exempt domestically controlled
partnerships) might be considered to address this
REIT, which is now the subject of proposed regulations.
differential. In that context, and REITs and RICs act
effectively as flow-through entities similar to partnerships,
Proposed Regulations
while ordinary corporations are subject to a corporate-level
The Treasury proposed significant regulatory changes
tax.
(REG-100442-22) on December 29, 2022. These changes
are targeted at the use of blocker corporations (intermediate
If all of FIRPTA were eliminated, there would be no tax on
investment entities that are domestic) that foreign persons
nonbusiness real property. There would also be a need to
invest in, which, in turn, are used to create a domestically
incorporate definitions of real property that are currently
controlled REIT. The proposed regulations would require
contained in Section 897.
taxpayers to take into account indirect foreign ownership
through REITs, regulated investment companies (e.g.,
Jane G. Gravelle, Senior Specialist in Economic Policy
mutual funds), and non-publicly traded partnerships. It
IF12498

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Foreign Investment in Real Property Act (FIRPTA)

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