Fed up with FIRPTA

When it was introduced in 1980, the Foreign Investment in Real Property Tax Act (FIRPTA) was intended to prevent farmland in America’s heartland from being consumed wholesale by overseas investors.

Almost 30 years since its enactment and FIRPTA is known to have had much wider consequences than prohibiting the acquisition of agricultural land and operations. Billed as an outdated, irrelevant, protectionist measure, opponents say FIRPTA has had a detrimental impact on US residential and commercial real estate markets by restricting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.

Until the credit crisis, such arguments gained little, if any, traction on Capitol Hill. However, in the wake of the collapse of real estate markets across the US, there are not only fresh calls for change – but signs that lawmakers may be paying attention.

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.
 
Although difficult to quantify, most real estate investors, especially foreign investors in US real estate, insist it does discourage investment in North American assets and for some a significant barrier to entry.

“If FIRPTA ever had a purpose it has long outlived it and now needs to be substantially reformed if not completely repealed,” says Jeffrey DeBoer, chief executive of the industry lobby group, the Real Estate Roundtable.

The Roundtable has been a long-time proponent of change on the issue, and this year included repeal of the tax in its five-point plan aimed at restoring liquidity to the US real estate markets.

“We now live in a global economy where capital should be flowing with as little burden as possible and the current rules are clearly an impediment to foreign investment in US equity real estate transactions,” says DeBoer.

The credit crisis isn’t the sole catalyst of demands for reform. Concerns over the tax were heightened in 2007 when the Internal Revenue Service (IRS) ruled against the use of private REITs by sovereign wealth funds as a means of avoiding FIRPTA. Foreign investors will often invest in US-controlled real estate investment trusts and blocker corporations to mitigate FIRPTA. IRS Notice 2007-55 though further muddied already murky waters by ruling that distributions from such entities to foreign shareholders were taxable.

“This ruling reawakened the debate about the tax in 2007,” explains Jay Zagoren, a partner at law firm Dechert’s finance and real estate group. But as he adds: “Now with real estate markets experiencing firesale situations, there is a greater urgency to calls for change.”

As DeBoer says, with politicians among those calling for new investment and capital to be injected into real estate, excluding foreign investors is simply counter-intuitive. “There is a tremendous need for new equity into US real estate owing to the dramatic deleveraging and repricing of the asset class.”

Conversations with politicians on Capitol Hill are in their formative stages but DeBoer says 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.

DeBoer concedes that whether the debate will translate into repeal or “something short of that”, it is too early to say. But to help further the debate, the Roundtable is planning to publish a survey quantifying the amount of additional equity US real estate could attract if FIRPTA was changed. The survey is expected to be published in the autumn.

“A lot of our members meet with non US investors who would like to invest more in the US, but are discouraged from doing so by FIRPTA,” DeBoer says. “This tax is discriminatory and needs to be repealed. Lowering this burden against foreign capital will help ultimately be very positive for US economic growth.”