United States real estate continues to be an attractive target for foreign investors seeking exposure to this asset class. However, due to U.S. FIRPTA rules (i.e., the Foreign Investment in U.S. Real Property Tax Act), tax structuring considerations often make the difference between a potential investment making financial sense or missing the mark.
REITs and Foreign Investment
A U.S. real estate investment trust (REIT) is one the most tax-efficient vehicles for these investments because a REIT that distributes all of its current operating income pays no tax at the entity level, and insulates a foreign investor from having to file a U.S. tax return with respect to this distributed income. Shares of a domestically controlled REIT are also exempt from FIRPTA tax on exit, provided the exit transaction is structured as a sale of REIT shares.
For foreign pension plans organized in a jurisdiction that has a beneficial tax treaty with the U.S., or which qualify as foreign “governmental” investors, distributions of operating income can be wholly exempt from U.S. tax, provided the investor owns less than 50 percent of the REIT. Gains realized from a sale of shares of a REIT that a foreign governmental investor does not control are also exempt form FIRPTA tax even if the REIT is not domestically controlled.
We have helped develop several innovative structures in recent years that allow for investing through REITs in a diverse range of properties, from hotels, multi-family residential, long-term housing, office, industrial and similar property, to healthcare properties and farmland. Several recent deals have used multiple REITs and parallel structures to own entire ground-up developments that feature a variety of uses, including uses that are not REIT-compliant, such as condominium developments, that are held in parallel tax vehicles. These structures have included features that allow delaying a final decision on the exact mix of components between REIT-eligible assets and non-eligible assets (primarily condominiums) until construction is underway.
Other innovations include structures that allow non-U.S. governmental investors to get a preferred return during an initial development phase and tax-efficiently convert to a non-controlled structure after the property is stabilized, as well as structures that allow exposure to assets owned by a U.S. investor seeking to defer the current realization of gain.
REITs can also be used to invest in newly originated loans without causing foreign investors to be considered to be engaged in a U.S. trade or business.
The ability to work within the rules to achieve a large variety of objectives continues to make REITs one of the most flexible avenues for a foreign investor to tax-efficiently structure a diverse range of investments in U.S. real estate.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2021 by Torys LLP.
All rights reserved.