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Structuring Foreign Investment in U.S. Real Estate Using Private Domestically Controlled REITs Steven Schneider, Director, Tax Group, Goulston & Storrs.

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Presentation on theme: "Structuring Foreign Investment in U.S. Real Estate Using Private Domestically Controlled REITs Steven Schneider, Director, Tax Group, Goulston & Storrs."— Presentation transcript:

1 Structuring Foreign Investment in U.S. Real Estate Using Private Domestically Controlled REITs Steven Schneider, Director, Tax Group, Goulston & Storrs PC, Washington, D.C. sschneider@goulstonstorrs.comsschneider@goulstonstorrs.com Daniel Carmody, of Counsel, Morgan Lewis & Bockius LLP, Philadelphia dcarmody@morganlewis.comdcarmody@morganlewis.com Richard C. LaFalce, Associate, Morgan Lewis & Bockius LLP, Washington, D.C. rlafalce@morganlewis.comrlafalce@morganlewis.com 1 February 4, 2015

2 Options for Investing in U.S. Real Estate 2

3 Direct Ownership Option Foreign Investor(s) real estate Single or multiple member limited liability company (see next page ) Only one level of taxation* Taxed at applicable tax rates for individuals, progressive capital gains rates up to 20% for corporations, progressive rates up to 35% Estate tax for individuals Privacy concerns *Additional Branch Profits Tax for Foreign Corporations 3

4 Domestic Corporation Structure Foreign Investor(s) Corporate level tax Dividend withholding tax Sale of stock is taxable unless real estate sold first in taxable sale Estate tax for individuals* No branch profits tax Limited privacy U.S. Corporation Real estate or ownership in pass- through or disregarded entities owning real estate * Sometimes avoided by inserting foreign corporation (zero tax country) above US corp 4

5 Leveraged Blocker Foreign Investor Real Estate = $100,000,000 NOI = $10,000,000 Dep. = $2,564,000 Int. Exp. = $6,000,000 Taxable Income = $1,436,000 Capitalization: $60 Million debt @ 10% $40M of equity U.S. Corp. 5

6 6 Participating Loans Foreign Investor U.S. Property Owner loan Contingent interest reflects property gains Interest amounts not subject to FIRPTA Loan itself is subject to FIRPTA Possible treaty rates for interest income Contingent interest not considered portfolio interest

7 The Domestically Controlled REIT (DCR) 7

8 Why a Domestically Controlled REIT? Foreign investors, particularly ones that are not used to paying tax (pension plans, sovereign wealth funds), pay so- called FIRPTA tax on the sales direct or indirect interests in US real estate. Sales of domestically controlled REIT stock is not subject to this tax. § 897(h)(2). Must exit by selling stock. Notice 2007-55 Tax applies even with investors from treaty countries since most treaties only exempt interest, ordinary dividends, and non-FIRPTA capital gains 8

9 Domestically Controlled REIT Real estate Non-U.S. Investor U.S. Investors JV REIT U.S. Investors 100 plus preferred investors 49.9%50.1% 100% common stock JV *Subject to “closely held” prohibition 9

10 What are the benefits of a DCR? No tax to non-US investor on sale SWF or treaty rules may also exempt or reduce tax on operating dividends REIT may reduce state/local taxes for out-of- state investors via dividends paid deduction 10

11 What are the costs of a DCR? No § 1031 on exit Potential TRS tax REIT compliance costs Potential corporate tax if fail REIT rules 11

12 What are the costs of a DCR? No pass-through of net losses REIT prevents real estate professional partner from avoiding Section 1411 tax Additional Reps and Warranties required on exit Closely held restrictions 12

13 Other Limitations in DCR structure No dealer property (i.e., no condos) Special REIT rules for hotels 100% prohibited transaction tax potential if sell before 2-year holding period Exit difficulties – When only one partner wants to sell – Potential haircut on price of selling stock 13

14 Overview of Business Limitations 1.U.S. investors must own, directly or indirectly, more than 50% of the value of all of the REIT’s shares. 2.The international investor must exit the investment by selling REIT stock (although the buyer likely will liquidate the REIT in order to achieve a step up in basis for the property and reduce future U.S. taxes). 3.Investments must meet REIT income and asset requirements, requiring annual testing of income and quarterly testing of assets, as well as review of leases and services to maintain REIT qualification. 4.REIT must make required distributions to avoid corporate level tax. 14

15 Overview of Business Limitations 5. More than 50% of the REIT’s shares, by value, cannot be held by five or fewer individuals, generally restricting both direct and indirect individual owners to less than 10%. 6. A REIT must have over 100 direct shareholders, which is generally satisfied for private REITs by specialty companies providing approximately 115-125 accredited investors for $1,000 of preferred stock each. 15


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