After years of delays, the much-anticipated reform of the 1980 Foreign Investment in Real Property Tax Act (FIRPTA) has become a reality.
The changes, which were part of the Protecting Americans from Tax Hike Act of 2015 that President Barack Obama signed into law in December, are intended to ease the tax burden of foreign institutions investing in US real estate.
The changes include the exemption of qualified foreign pension funds from FIRPTA taxation on gains they derive from the sale of US real estate interests or distributions on shares owned in real estate investment trusts; as well as raising a shareholder’s maximum stock ownership in a publicly traded corporation from 5 percent to 10 percent before being subject to FIRPTA tax withholding.
Overall, the FIRPTA changes are anticipated to drive more cross-border capital into US real estate. “The recent legislation bringing welcome relief from certain FIRPTA taxes should provide additional incentives for foreign investment into the US,” said James Fetgatter, chief executive of the Association of Foreign Investors in Real Estate (AFIRE), in a statement last month.
In AFIRE’s 2016 annual survey of its members, the US ranked first among countries that provided the best opportunity for capital appreciation, despite the fact that 80 percent of respondents found it difficult to find attractive real estate opportunities in the country. Some industry professionals have attributed this seeming contradiction to anticipation of the FIRPTA reform.
In fact, Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, estimated that the FIRPTA changes could spur an additional $20 billion to $30 billion in foreign investment in US commercial real estate in 2016. Cross-border capital into the US clocked in at $92.5 billion last year, more than double the 2014 volume of $45 billion, according to data provider Real Capital Analytics.
Eric Wurtzebach, senior managing director at Macquarie Capital, noted that FIRPTA reform is being factored into the global allocations of some large European institutions – particularly Dutch and Danish pension funds – which have now seen a previous 20 percent tax on a property sale removed.
“Many European pensions required a domestically controlled REIT to invest in the US, which restricted opportunities,” said Wurtzebach. “This is no longer an issue, so you would expect more capital to come in from those institutions.”
However, the overall projected increase in cross-border capital into the US will have less to do with FIRPTA than with other factors, he said. “The actual amount will not be driven by the tax change, it will be driven by market reaction to slowing China growth and the significant global stock market volatility,” he said. “In short, market performance will be the real driver of additional demand, not the change in tax law.”
Meanwhile, Jeffrey Horwitz, co-head of the private equity real estate practice at law firm Proskauer Rose, said that FIRPTA had never been a major impediment to cross-border US real estate deals getting done, but rather had affected the structure and attractiveness of those deals.
What would have a greater impact on foreign investors in US real estate would be changes to Section 892 of the Internal Revenue Code of 1986, which currently grants a federal income tax exemption to foreign governments on income from certain US investments, including stocks, bonds and other securities, he said. “The best step to improve cross-border investment in the US would be to broaden the section 892 exemption to cover all real estate investments.”
Indeed, as tax and advisory services firm EY noted in its global market outlook 2016 report, the FIRPTA tax exemption would benefit only non-US pension funds, not all foreign investors: “By exempting qualifying foreign pension funds from US federal income tax on gains from US real property entirely, this (tax exemption) would appear to put foreign pension funds in a more favorable tax position than sovereign wealth funds, many of which have a strong appetite for US real estate and represent a substantial pool of capital for investment.”