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How FIRPTA can Affect Foreign Investments in U.S. Real Estate

March 18, 2015

5 considerations that could impact your foreign investment structure.

The U.S continues to see strong foreign demand for investment in U.S real estate. It is critical for any foreign investor to understand the U.S. tax considerations of an investment in U.S. real estate. Failure to properly plan the structure of the investment can have big consequences. These consequences may impact the investor’s return, timing of cash flows, and U.S. reporting requirements. With this in mind, understanding the following considerations will impact the choice of investment structure:

  1. Who is the investor? Investors may be foreign individuals, trusts, partnerships, corporations or any combination. Is there more than one investor? Of what country are they a resident? Will the investor make the investment directly?
  2. Nature of the investment. The investor may want a “simple” passive investment in a rental property. In contrast, the investor may have designs to use the investment in a real property intensive business.
  3. Investment objective. The objective may be capital appreciation, cash flow, a hedge as part of a broader investment portfolio, the perceived safety of U.S. real estate, or any number of other objectives.
  4. Funding. It is important to consider the manner and magnitude of anticipated funding. What is the source of funds? Will funds be made available in tranches over time? Will funds be made available from overseas?
  5. Cash Flow. Finally, consider the timing of cash flows and anticipated holding period of the investment. Does the investor expect to take regular distributions? Does the investor have a long or short term horizon in mind for exiting the position?

With all of these considerations in mind, as well as any others that are unique to the situation, -and every situation is unique, -the structure for the investment needs to be properly considered. The United States regime for the taxation of a “U.S. Real Property Interest” is complex and fraught with various withholding, compliance and notice requirements. For example,

  • Definitions and tests to determine what constitutes a U.S. Real Property Interest;
  • Rules for determining when an indirect transfer of the interest may be taxable;
  • Key responsibilities for withholding agents involved in a sale or exchange of an interest; and
  • Onerous U.S. income tax filing and compliance requirements for the foreign investors.

Failure to properly comply can have costly consequences to the unwary foreign investor. This could include, for example,

  • Withholding of 10% of the gross proceeds for which the investor must file a refund claim;
  • Significant penalties or interest due to compliance failures;
  • Significant – perhaps unnecessary - costs of tax compliance and administration; or
  • Failure or delays of the completion of a sale of the investment.

If you need assistance with understanding the rules for foreign investment in U.S. real estate and how they affect your investment plans, please contact a member of the KLR Global Tax Services Group.

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