A thought piece from two US economists makes a case for repealing the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), concluding that such a change would bring relief to the struggling commercial real estate market.
When it was introduced in 1980, FIRPTA was intended to prevent farmland in America's heartland from being consumed wholesale by overseas investors. Currently, the FIRPTA tax requires sellers of real assets in the US, who are not resident aliens or US citizens, to allow buyers to withhold part of the gains from any disposition for taxable purposes. The tax is usually 10 percent of the sales price but can be up to 35 percent – and comes on top of all other US taxes paid by the overseas investor or foreign corporation.
Billed as an outdated, irrelevant, protectionist measure, opponents say FIRPTA has had a detrimental impact on US residential and commercial real estate markets by restricting additional equity investment in the asset class.
The authors of the piece, Martin Neil Baily and Matthew Slaughter, say the tax is discriminatory on two levels: it places foreign real estate investors at a disadvantage relative to US investors, and it makes other types of US assets, including equities and Treasury securities, more appealing than real estate to foreign investors.
In making the case for the repeal of FIRPTA, the authors say that making US real estate more appealing to foreign investors could help ease the crushing refinancing burden the commercial real estate market faces in coming years – they estimate that $350 billion in CRE debt must be retired or rolled over each year, with 65 percent of commercial mortgages unlikely to qualify for refinancing.
Currently, a foreign investor seeking a 10 percent return on a US investment would have to restrict its investment to projects that would earn a return of 15.4 percent or more to meet that target after taxes. For this reason, foreign investors “regularly cite FIRPTA as an important consideration in their portfolio choices”, the authors say.
The authors also say that allowing more foreign capital into the sector would cause permanent long-run productivity gains for office buildings, retail and industrial properties, hotels and commercially owned residential apartment units. They also predict that foreign investment in real estate could help to offset the US's current-account deficit.
An outright repeal of FIRPTA would cost $8.3 billion over 10 years in lost tax revenues, the authors acknowledge. But the authors say “the sizable economic benefits of reforming FIRPTA would exceed the small fiscal costs”.
Baily is a senior fellow at Brookings, and served as chairman of the Council of Economic Advisors during the Clinton administration. Slaughter is an associate dean at the Tuck School of Business, and served as a member of the Council of Economic Advisors during the George W. Bush Administration.
In the wake of the financial crisis, there have been signs that members of Congress are open to rethinking FIRPTA. According to Jeffrey DeBoer, chief executive of industry lobbying group Real Estate Roundtable, legislators are keen to learn more about FIRPTA and its impact on US real estate.
“The meetings we have had have been very productive and engaging and I think they will ultimately result in some change to FIRPTA,” he says.