Congressional Proposals Seek To Promote Foreign Investment In U.S. Real Estate

On July 31, Representative Kevin Brady (R-TX) introduced H.R. 2870 to amend the Foreign Investment in Real Property Tax Act ("FIRPTA"), the tax regime governing foreign investment in U.S. real estate. The proposal is a companion bill to S. 1181, introduced by Senator Robert Menendez (D-NJ) on June 18, and both Congressional bills are reprisals of legislation proposed in 2010 and 2011.

The Congressional proposals—each titled Real Estate Investment and Jobs Act of 2013—are backed in both chambers on a bipartisan basis and are intended to promote greater foreign investment in real estate investment trusts ("REITs"). The proposals follow on the heels of an announcement by the White House earlier this year, which outlined the Obama administration's goal of promoting greater foreign investment in U.S. real estate by changing the application of FIRPTA with respect to foreign pension fund investors.

Background

As discussed in a prior Commentary (available upon request) on the competing White House proposal, commentators have been critical of FIRPTA since its inception in 1980. FIRPTA made gains from the disposition of U.S. real property interests taxable in the hands of foreign investors and, in the view of many, creates a barrier to foreign investment. According to Senator Robert Menendez (D-NJ), FIRPTA imposes

significant penalties on foreign investments in domestic real estate that do not exist on other types of U.S. investments such as corporate stocks and bonds. These rules ... freeze out foreign investment in our real estate markets by imposing an arbitrary withholding tax on the gains realized by overseas capital invested in domestic properties.

Legislation has been periodically introduced that would abolish or significantly reduce the effects of FIRPTA. Although attempts at legislative change have thus far been unsuccessful, many believe that the time for change may finally be ripe, spurred principally by economic circumstances. By 2018, it is expected that more than $2 trillion in loans, including commercial mortgage-backed securities, will mature. Without increased foreign investment in these items, significant amounts of debt may go into default, triggering foreclosures and decreased property values. The threat of impending default and foreclosure, combined with continued economic stagnation, may prompt legislators to focus more intently on proposals that are expected to bring capital into the United States.

The Proposals

The Congressional proposals focus exclusively on promoting foreign investment in the stock of REITs and do four things:

Reverse part of IRS Notice 2007-55 (the "Notice") such that liquidating distributions from a REIT to a foreign shareholder are tax-free; Increase the ownership ceiling for the publicly traded FIRPTA exception from 5 percent to 10 percent with respect to REIT investments by foreign persons; Create a new FIRPTA exception for certain foreign investors who are 10 percent or less holders of REIT stock, regardless of whether the REIT is publicly traded; and Add helpful presumption rules to ease the...