Presentation on theme: "Structuring Foreign Investment in U. S"— Presentation transcript:
1 Structuring Foreign Investment in U. S Structuring Foreign Investment in U.S. Real Estate Using Private Domestically Controlled REITsSteven Schneider, Director, Tax Group, Goulston & Storrs PC,Washington, D.C.Daniel Carmody, of Counsel, Morgan Lewis & Bockius LLP,PhiladelphiaRichard C. LaFalce, Associate, Morgan Lewis & Bockius LLP,Washington, D.C.February 4, 2015
3 Direct Ownership Option Foreign Investor(s)Only one level of taxation*Taxed at applicable tax ratesfor individuals, progressive capital gains rates up to 20%for corporations, progressive rates up to 35%Estate tax for individualsPrivacy concernsSingle or multiple member limited liability company(see next page)real estate*Additional Branch Profits Tax for Foreign Corporations
4 Domestic Corporation Structure Foreign Investor(s)Corporate level taxDividend withholding taxSale of stock is taxable unless real estate sold first in taxable saleEstate tax for individuals*No branch profits taxLimited privacyU.S.CorporationReal estate or ownership in pass-through or disregarded entities owning real estate* Sometimes avoided by inserting foreign corporation (zero tax country) above US corp
5 Leveraged Blocker Foreign Investor U.S. Corp. Capitalization: $60 Million 10%$40M of equityU.S. Corp.Real Estate = $100,000,000NOI = $10,000,000Dep. = $2,564,000Int. Exp. = $6,000,000Taxable Income = $1,436,000
6 Participating Loans Foreign Investor Interest amounts not subject to FIRPTALoan itself is subjectto FIRPTAPossible treaty ratesfor interest incomeContingent interest notconsidered portfoliointerestForeign InvestorContingent interest reflects property gainsloanU.S. Property Owner
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. NoticeTax applies even with investors from treaty countries since most treaties only exempt interest, ordinary dividends, and non-FIRPTA capital gains
9 Domestically Controlled REIT Non-U.S. InvestorU.S. Investors49.9%50.1%JVJV *Subject to “closely held” prohibitionU.S. Investors100% common stock100 plus preferred investorsREITReal estate
10 What are the benefits of a DCR? No tax to non-US investor on saleSWF or treaty rules may also exempt or reduce tax on operating dividendsREIT may reduce state/local taxes for out-of-state investors via dividends paid deduction
11 What are the costs of a DCR? No § 1031 on exitPotential TRS taxREIT compliance costsPotential corporate tax if fail REIT rules
12 What are the costs of a DCR? No pass-through of net lossesREIT prevents real estate professional partner from avoiding Section 1411 taxAdditional Reps and Warranties required on exitClosely held restrictions
13 Other Limitations in DCR structure No dealer property (i.e., no condos)Special REIT rules for hotels100% prohibited transaction tax potential if sell before 2-year holding periodExit difficultiesWhen only one partner wants to sellPotential haircut on price of selling stock
14 Overview of Business Limitations U.S. investors must own, directly or indirectly, more than 50% of the value of all of the REIT’s shares.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).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.REIT must make required distributions to avoid corporate level tax.
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 accredited investors for $1,000 of preferred stock each.