After years of defeated reform proposals, real estate managers have been wondering just how long they’ll have to put up with the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), which requires non-US investors to pay a 10 percent withholding tax on the sale of US property investments.
Does the latest attempt at legislative change – the Real Estate Investment and Jobs Act of 2015 proposed by Rep. Kevin Brady earlier this year – stand a chance? We asked Goodwin Procter tax partner Mark Kirshenbaum for an inside take on the current situation.
After 35 years, why is FIRPTA still a top-of-mind issue for private real estate managers?
Kirshenbaum: FIRPTA is critical in their world because we’re seeing such a significant portion of capital coming into real estate funds from non-US sources—sovereign wealth funds, and in some cases non-US pension plans—and a lot of those investors are extremely sensitive to paying tax under FIRPTA. For some of them, it can be a precondition to coming into the fund that the sponsor will structure the investments so that there won’t be any FIRPTA tax, either through sales of stock in real estate investment trusts (REITs) or through other structures that would include corporate blockers. However, these structures can be economically inefficient and can hinder the manager’s ability to execute its intended strategy, thereby potentially causing tension with other potential investors.
What’s the biggest challenge facing private fund CFOs when it comes to FIRPTA reform as it stands today?
The biggest challenge is the great deal of uncertainty. Since FIRPTA was enacted, the US Treasury department was directed to write regulations on how to implement the tax rules for when REITs pay capital gains dividends out to non-US investors. The Treasury department just hasn’t written those regulations. So there’s a high degree of uncertainty about how much a fund has to withhold when a REIT makes a distribution up to a fund with non-US partners when the REIT has disposed of US real property interests.
Are investment managers seeing hope in proposals like the ‘Real Estate Investment and Jobs Act of 2015’ to institute the necessary reforms?
Managers are going about business as usual in part because there’s uncertainty about that bill, but also because that bill isn’t really designed to be that helpful to private REITs. The big question for private funds is whether Congress is going to reverse the Treasury department’s view on liquidating distributions from domestically controlled REITs and capital gains dividends to non-US sovereign wealth funds.
The Brady bill has two pieces. It takes the publicly traded limit on capital gains from 5 percent to 10 percent, but that doesn’t help at all for private funds. The part of this proposal that would be helpful for them is that it does exempt certain foreign pension plans from FIRPTA tax, including on structures where they use a REIT but the REIT sells its assets, which is important because Dutch and Canadian pension plans, for example, are significant sources of capital for private funds. It doesn’t help sovereign wealth funds, though, and that’s where the biggest chunk of money is coming from. If the bill was extended to apply the pension plan exemption to foreign sovereign wealth funds and governmental pension plans, that would have a very material, positive impact for fund managers.
There is some hope for those reforms to go through, but everything in Washington is extremely unpredictable right now. Accordingly, in a typical fundraising cycle, no one is in the position to bet that that bill will pass so it’s not helping anybody in advance. People are really just working with the existing framework, and supporting some of the lobbying efforts, particularly by the Real Estate Roundtable.