On December 18, 2015, Congress passed the Protecting Americans from Tax Hikes Act of 2015 (“PATH”), the permanent “extenders” legislation. Included among the provisions are many potentially significant changes affecting REITs and foreign investment in U.S. real property through REITs. This newsletter highlights a few of the provisions.
REIT Spinoffs Disallowed
The extenders bill would prohibit tax-free spinoffs where either the distributing or controlled corporation is a REIT, and would institute a 10-year prohibition on electing REIT treatment for any corporation involved in a spinoff. The provision applies to distributions occurring on or after December 7, 2015, but grandfathers distributions for which a ruling request was submitted to the IRS on or before such date. An exception is provided for spinoffs of taxable REIT subsidiaries in certain circumstances.
Publicly Traded REITs Increases Exception to 10% from 5% Under FIRPTA
FIRPTA (the Foreign Investment in Real Property Tax Act of 1980, which is set forth in Sections 897 and 1445 of the Code) subjects foreign persons to tax on the sale of U.S. real property interests, including shares of stock in a corporation more than 50% of the value of the assets of which is attributable to U.S. real property interests. There is an exception for shares of publicly traded stock in the case of shareholders who have held 5% or less of such shares over the previous 5 years. The extenders bill would increase the threshold to 10% for shares of publicly traded REITs. The provision does not affect shares in corporations other than REITs.
Similarly, FIRPTA taxes foreign persons, on a net income basis, on distributions from REITs, generally to the extent such distributions are attributable to gain from the sale of U.S. real property interests. In the case of publicly traded REITs, only distributions made to shareholders owning more than 5% of the shares at any time in the 1-year period prior to distribution are subject to FIRPTA. The provision also increases this threshold to 10%.
Accordingly, the extenders bill would permit offshore funds to hold a larger position (up to 10%) in publicly traded REITs without incurring U.S. tax liability on the sale of shares or on capital gains distributions. Note that 30% withholding tax on dividends would still apply to all dividends, including capital gains distributions.
Calculating “Domestic Control” for Purposes of Determining DREIT Status
Shares in REITs that are domestically controlled – i.e., REITs that are owned less than 50% by foreign persons during the applicable testing period – are not considered U.S. real property interests under FIRPTA, and can therefore be sold by foreign investors without incurring federal income tax on gains on sale. The extenders bill would change the calculation of domestic control for publicly traded REITs such that less than 5% shareholders would be treated as U.S. persons unless the REIT has actual knowledge otherwise. This would be beneficial in that more shareholders may qualify as domestic and less due diligence may be required by the REIT in making this determination