Foreign Investment in Real Property Act (FIRPTA)

https://crsreports.congress.gov

September 18, 2023

In general, a foreign person or corporation is not taxed on

U.S.-source capital gains income unless it is associated with

operating a trade or business. However, under the Foreign

Investment in Real Property Tax Act (FIRPTA), gain on the

sale of U.S. real property is taxed at the same rates that

apply to U.S. sellers. To ensure collection of this tax, the

buyer is required to withhold part of the purchase price and

submit a payment to the Internal Revenue Service, unless

the sale falls under one of several exceptions. The foreign

investor then files a U.S. tax return which can be used to

refund part of the withholding tax if it exceeds the tax on

the gain.

The FIRPTA rules were adopted in 1980, as part of the

Omnibus Reconciliation Act of 1980 (P.L. 96-499). The

general rationale was to equalize the tax treatment of

foreign and domestic investors, although it was also partly

in response to concerns about purchases of U.S. farm land

by foreign investors.

FIRPTA Tax Rules

FIRPTA rules treat the gain from the sale of real property

as effectively connected income associated with a U.S.

business and thus subject to the same tax as a U.S. seller

(Section 897 of the Internal Revenue Code). Individuals are

taxed at capital gains tax rates (generally 15% and 20%)

and corporations at the corporate rate of 21%.

The tax applies to real property located in the United States

and the Virgin Islands. The inclusion of the Virgin Islands

was to avoid, under the Virgin Island mirror tax code

(which effectively applies U.S. tax rules to Virgin Islands

residents), the use of a Virgin Islands corporation to avoid

the tax on gains on U.S. real property.

The tax applies to direct holdings of real property and to

major holdings in certain U.S. real property holding

corporations (USRPHC). A USRPHC is a corporation that

has 50% or more of its assets (real property plus assets used

in the trade or business) in U.S. real property. The most

common example of this type of corporation is a real estate

investment trust (REIT). REITs are corporations that issue

shares of stock, are largely invested in real property, and do

not generally pay corporate tax. REITs distribute and

deduct most income as dividends to shareholders.

Individual shareholders pay tax at ordinary individual

income tax rates on those dividends (rather than the lower

rates normally applied to dividends on corporate stock).

REITs also distribute capital gains, which are taxed under

the capital gains tax, similarly to a partnership.

The FIRPTA tax does not apply to USRPHCs that are

REITs or regulated investment companies that are

domestically controlled, in that they are less than 50%

owned by foreign investors. As a result, domestic REITs

can be used for foreign investors to hold an interest in U.S.

real property without being taxed.

Exemptions

Foreign governments and pension funds are exempt from

the FIRPTA tax.

FIRPTA does not apply if (1) the investment is made

through a qualified investment entity; (2) the U.S. real

property is regularly traded on an established U.S. securities

market; and (3) the recipient foreign person or corporation

did not hold more than 5% of that class of stock or

beneficial interest within the one-year period ending on the

date of distribution. (The American Jobs Creation Act of

2004 [P.L. 108-357] extended the exception to cover capital

gains distributions as well as stock sales.) A special rule

adopted in the Protecting Americans from Tax Hikes

(PATH) Act of 2015, enacted as part of the Consolidated

Appropriations Act, 2016 (P.L. 114-113), increased the

foreign ownership requirement to 10% for REITs.

Sales that are eligible for nonrecognition under other rules,

such as corporate reorganizations and like-kind exchanges

(Section 1031), are generally treated the same under

FIRPTA. Taxes on gain are deferred until the property

acquired in the exchange is sold. Section 1031 does not,

however, apply to the exchange of a U.S. property for a

foreign property.

FIRPTA Withholding Taxes

FIRPTA withholding taxes were enacted in the Deficit

Reduction Act of 1984 (P.L. 98-369). These rules require

the purchaser of real property or interests in real property

from a foreign person to withhold taxes (Section 1445

Internal Revenue Code). The PATH Act increased the

general FIRPTA withholding rate from 10% to 15% of the

price of the property. This withholding is transmitted on

IRS Form 8288 along with a withholding statement 8288-

A. The rules also require partnerships, estates, trusts,

foreign corporations, and in some cases domestic

corporations to withhold tax on distributions of gain subject

to FIRPTA at the highest tax rate that would apply under

the income tax.

No withholding is required if the property is purchased by

an individual for use as a residence and the property is sold

for $300,000 or less. A lower withholding rate of 10%

applies if the property is purchased for use as a residence

and is sold for $1 million or less.

No withholding is required in several other circumstances,

including dispositions of stock in a publicly traded

corporation and when affidavits are received indicating that

Foreign Investment in Real Property Act (FIRPTA)

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a privately traded corporation is not a USPRHC or that

other arrangements have been made.

One issue that may be encountered by purchasers of

property of a foreign person is when the sale is part of a

Section 1031 like-kind exchange. In such cases, the

FIRPTA rules allow for the tax to be deferred. While the

tax could be recouped on a subsequent tax return, the seller

can submit an 8288-B (Application for Withholding

Certificate for Dispositions by Foreign Persons of U.S. Real

Property Interests) in advance of the sale. The foreign

purchaser can also deposit the tax with the settlement agent

and thereby be able to receive and reinvest the full purchase

price (thereby avoiding tax on the withholding amount that

would apply if it is not reinvested).

Revenue Effect

In 2008, the Joint Tax Committee estimated the revenue

gain from FIRPTA was less than $50 million. This

provision was treated as a negative tax expenditure, that is,

a gain rather than a loss. FIRPTA has not subsequently

been included in tax expenditure lists. Estimates of the

revenue effects of revisions in the PATH Act indicate a

larger pre-2015 amount, as the provisions increasing the

share of stock owned in REITs to 10% were projected to

lose about $100 million per year and the provision

excluding pension funds was estimated to lose around $120

million. The provision increasing the withholding rate on

direct sales of property from 10% to 15% was much

smaller, gaining about $20 million.

As noted below, one reason for the limited revenue

collected from FIRPTA may be the ability to set up blocker

corporations to create an exempt domestically controlled

REIT, which is now the subject of proposed regulations.

Proposed Regulations

The Treasury proposed significant regulatory changes

(REG-100442-22) on December 29, 2022. These changes

are targeted at the use of blocker corporations (intermediate

investment entities that are domestic) that foreign persons

invest in, which, in turn, are used to create a domestically

controlled REIT. The proposed regulations would require

taxpayers to take into account indirect foreign ownership

through REITs, regulated investment companies (e.g.,

mutual funds), and non-publicly traded partnerships. It

would also include regular U.S. corporations if foreign

persons own 25% or more of the fair market value of stock.

Proposals and Issues

In the 116

Congress, Representative Larson introduced a

bill, H.R. 2210, to repeal FIRPTA. Also in the 116

Congress, Representative Suozzi introduced a bill, H.R.

4598, to allow foreign insurance companies to be exempt

from FIRPTA. In the 117

Congress, Representative Suozzi

introduced a bill,

H.R. 3123

, to allow nontraded publicly

offered REITs the exemptions available to publicly traded

REITs.

The primary argument for eliminating FIRPTA, which the

real estate industry has long advanced, is that it discourages

foreign investments in U.S. property, including

infrastructure property. The magnitude of such an effect is

not known.

As discussed in detail in a 2013 law review article by

Professor Willard B. Taylor, a Treasury study prior to

enactment of FIRPTA found that foreign ownership of land

was insignificant. Treasury, however, was concerned about

the different treatment of investors in business property

who were able to avoid tax under the “effectively

connected” rule. Taylor points out that investment through

partnerships is typically subject to tax because the

partnership is involved in a trade or business. If just the

FIRPTA rules affecting USRPHCs were eliminated, the tax

would still be imposed depending on the form of the

investment through a REIT or RIC (regulated investment

company) as compared to a partnership, so that some

alternative rules (such as treating REITs the same as

partnerships) might be considered to address this

differential. In that context, and REITs and RICs act

effectively as flow-through entities similar to partnerships,

while ordinary corporations are subject to a corporate-level

tax.

If all of FIRPTA were eliminated, there would be no tax on

nonbusiness real property. There would also be a need to

incorporate definitions of real property that are currently

contained in Section 897.

Jane G. Gravelle, Senior Specialist in Economic Policy

IF12498

Foreign Investment in Real Property Act (FIRPTA)

https://crsreports.congress.gov | IF12498 · VERSION 1 · NEW

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