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Foreign Investment in U.S. Real Estate: Portfolio Interest

Exemption and IRC 163(j) Interest Limitations

TUESDAY, DECEMBER 17, 2019, 1:00-2:50 pm Eastern

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December 17, 2019

Foreign Investment in U.S. Real Estate: Portfolio Interest Exemption and IRC 163(j) Interest Limitations

Richard S. Lehman, Attorney

United States Taxation

[email protected]

Michael D. Melrose, Attorney

Baker & McKenzie

[email protected]

Paul O'Quinn, Attorney

Baker & McKenzie

paul.o'[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

Agenda

1 Overview of applicable tax rules 3

2 Structuring and entity selection 30

3 Portfolio interest exemption ("PIE") & Treaties 38

4 New Section 163(j) interest limitation & 267A 45

5 REIT Structures 56

Richard S. Lehman

Mr. Lehman began his career in tax law with a law degree from

Georgetown University, a Master’s Degree in tax law from New York

University, and two years of clerking for the Honorable William M. Fay,

a Judge on the United States Tax Court in Washington, D.C. Mr.

Lehman spent several years as the senior attorney of the Interpretive

Division of the Chief Counsel’s office at the Internal Revenue Service,

the IRS's internal law firm.

Mr. Lehman has had extensive experience with all areas of the Internal

Revenue code that apply to American taxpayers and non-resident

aliens and foreign corporations investing or conducting business in

the United States, as well as U.S. citizens and domestic corporations

investing abroad.

Richard works with other lawyers, accountants,

business leaders and individuals who are

struggling to find their way through the

complexities of United States Tax Law.

ATTORNEY AT LAW

Richard S. Lehman,

Esq.

1900 Corporate Blvd.

Suite 301W

Boca Raton, FL 33431

Tel: 561-368-1113

www.LehmanTaxLaw.co

m

Lehman has been practicing in South Florida for nearly 50 years.

6

Foreign Real Estate Investor

Tax Planning Techniques

— ADVANCED COURSE —

By Richard S. Lehman Esq.

7

I. Principle Objectives

• Limited Personal and Asset Liability

• Single U.S. Tax

• Avoid Double Taxation – U.S. and

Country of Investor

• Confidentiality

• Tax Planning– Eliminate U.S. Taxation of Real Estate

Income and Gains

– Eliminate U.S. Estate and Gift Tax

– Eliminate U.S. Branch Tax on Foreign

Corporations

– Single Tax

– Deferral of Payment of Tax

– Reduce Tax Rates

II. Basics

• Tax Rates

• Taxable Persons and Entities– Foreign Individual Investor

– Limited Liability Company of Partnership

– The U.S. Corporation

– Foreign Corporation

– Foreign Trusts

III. Planning Techniques

• Avoidance of the Double Tax - Gains

• Elimination of the U.S. Estate and

Gift Tax and the Branch Tax

• The Foreign Trust – U.S. Estate Tax

Avoidance and Income Tax Benefits

• Tax Bracket Advantages and

Individual Planning

• Avoidance of the Double Tax

• Tax Free Income

• Partially Tax Free Income

• Tax Treaties

Foreign Real Estate Investor Tax Planning TechniquesBY RICHARD S. LEHMAN, ESQ.

SEMINAR OUTLINE

8

OUTLINE: Planning Techniques

• Avoidance of the Double Tax on Gains

• Elimination of the U.S. Estate and Gift Tax and

the Branch Tax

• The Foreign Trust – U.S. Estate Tax Avoidance

and Income Tax Benefits

• Tax Bracket Advantages and Individual Planning

• Avoidance of the Double Tax – Other Countries.

• Tax Free Income

• Partially Tax Free Income

• Tax Treaties

TAX ATTORNEY: Richard S. Lehman, Esq • Tel: 561-368-1113 • www.LehmanTaxLaw.com

9

http://www.lehmantaxlaw.com/

OUTLINE: Principle Objectives

• Limited Personal and Asset Liability

• Single U.S. Tax

• Avoid Double Taxation – U.S. and Country of Investor

• Confidentiality

• Tax Planning– Eliminate U.S. Taxation of Real Estate Income and Gains

– Eliminate U.S. Estate and Gift Tax

– Eliminate U.S. Branch Tax on Foreign Corporations

– Single Tax

– Deferral of Payment of Tax

– Reduce Tax Rates


10


OUTLINE: Basics

• Tax Rates

• Taxable Persons and Entities

– Foreign Individual Investor

– Limited Liability Company of Partnership

– The U.S. Corporation

– Foreign Corporation

– Foreign Trusts


11


Foreign Investors – Income Tax

• Non Resident Alien Individuals and Foreign Corporations (“Foreign Investors”) that

invest in U.S. real estate are taxed similar to U.S. Individual Taxpayers and U.S.

Corporations on their U.S. real estate income.

The term “Foreign Investors” is used for:

foreign individual(s) and foreign entities

12

Foreign Investors – Income Tax

Similarities

• Foreign Investors in U.S. real estate will be taxed on their

ordinary income, whether it is from operating income such

as rentals or inventory sales or other income producing

transaction from U.S. real estate.

• Foreign Individual Investors, like American individuals will

be taxed on their capital gains from the sale of investment

real estate at lower tax rates than ordinary income.

• Foreign Corporations, like U.S. Corporations, have the

same rate of tax imposed on capital gains and operating

income

13

Foreign Investors – Estate & Gift Tax

1. A drastic difference between the U.S. estate and gift tax

laws that govern U.S. persons and Non Resident Individuals

who may die owning U.S. real estate, or foreign individual

investors who give gifts of U.S. real estate to third parties.

2. The U.S. gift taxes and estate taxes on Foreign Investor(s)

are prohibitive and can be as high as 40% of the net value of

the real property gifted or demised.

3. Only a small amount of the value of the real estate,

($60,000), may be a gift or left as an inheritance during the

Foreign Investor’s life without paying U.S. estate or gift

taxes.

4. The U.S. estate and gift taxes can be avoided.

14

Foreign Investors – Branch Tax

• There is also a unique tax on Foreign

Corporations that build cash reserves from

earnings and profits in the U.S.

• They must either reinvest cash in U.S. assets,

or distribute the cash as dividends or suffer a

tax known as “Branch Tax”.

• This can be an additional 30% tax on profits in

addition to the foreign corporate income tax.

• This is another tax that can be planned around.

15

Foreign Investors – Tax Benefits

Because of the laws that favor foreign

investments in the United States; and because of

certain advantages that a Foreign Investor may

find if a U.S. Tax Treaty governs the Foreign

Investors, there can be significant differences and

benefits for Foreign Investors in U.S. real estate;

many of which are not enjoyed by American

Investors.

16

History of the Real Estate Taxation

• In the 1980s a new section was added to the

Internal Revenue laws: Code Section 897

• A unique set of tax rules that apply only to real

estate income. An attempt to make sure that a

Foreign Investor paid at least one U.S. tax on

operating income and one tax on capital gain.

• It is often possible for a Foreign Investor to pay

no tax on income that is essentially derived from

real estate profits.

17

Investment and Tax Objectives

Principal objectives that affect the

Foreign Investor in U.S. real estate

18

Limited Personal and Asset Liability

Insurance

The first solution for the protection of the asset and the

owner is providing for the proper liability insurance for the

investment. Insurance policies covering liability for the typical

injuries or damages that may occur on a real estate property

are readily available in the U.S. from designated Insurance

Brokers.

Entity Choice

The second solution for the asset is the proper entity choice

so the real estate asset is not exposed to liabilities of other

assets owned by the Foreign Investor and vice versa and

more importantly so that the Foreign Investor is not

personally liable for any damages that may result from the

real estate investment.

19


Single U.S. Tax.

• The Foreign Investor will want an entity that

will facilitate the paying of only a single tax on

U.S. operating profits and a single U.S. tax on

gains from sale.

20


Avoid Double Taxation – United States

and Country of Investor.

•Between the two countries, a single tax should be

paid to the U.S. on real estate income and the U.S.

tax or the other countries’ tax may be appropriately

credited among the income taxes of each country.

It is important to maximize the tax credits to avoid

double taxation between the two countries.

21


Confidentiality

•The Foreign Investor often is concerned with

the preservation of confidentiality for fears of

kidnapping in their own country and a number

of other reasons. Therefore, generally the

Foreign Investor would prefer an entity that

requires as little disclosure of their personal

information as possible on U.S. tax returns and

U.S. information returns.

22


Tax Planning

•The proper use of entity choices can take

advantage of the following:

1. Tax deductions for expenses

2. Tax exclusions of certain types of income

3. The ability to defer the payment of taxes to a

later date that is provided to Foreign Investors

under the U.S. tax system.

23

Tax Planning tools will allow

Foreign Investor to:

1. Eliminate U.S Taxation of Real Estate Income and Gains. Totally

and/or partially eliminate U.S. taxes on certain real estate

income and gains.

2. Eliminate U.S. Estate and Gift Tax. The U.S. Estate and Gift tax

can be completely eliminated with the proper entity choice.

3. Eliminate U.S. Branch Tax on Foreign Corporations. Eliminate

U.S. Branch taxes with the proper entity choice.

4. Single Tax. Insure that only a single U.S. tax will be paid on real

estate profits.

5. Deferral of Payment of Tax. Defer taxation of gains on real

estate profits that are realized for payment at a later date than

the realization of these gains.

6. Reduce Tax Rates. Proper planning can assure that income is

reported in the lower tax brackets among groups of investors.

24

Individual Tax Payer

U.S. Corporations

Foreign Corporations

Operating Income

& Gains from Sale

26

Minimum and Maximum Individual Tax Rate TAX RATES

• Operating Income 10% to 37%

• Capital Gains Tax 10% to 20%

Minimum and Maximum Corporate Tax Rate

for U.S. and Foreign Corporations

TAX

RATES

• Operating Income 21%

• Capital Gain Maximum of 21% plus

deductible State

Corporate Income Tax

(Corporate Income Tax not in all states)

27

Passive Income

Maximum U.S. Tax Rate – Interest Income 30%

Payable to Foreign Creditor 15% or less,

Treaty

Maximum U.S. Tax Rate – Dividends 30%

Payable to Foreign Shareholders 15% or less,

Treaty

Corporations

TAX RATES

28

Maximum Use of Investment Entity

INDIVIDUAL

• Personal Liability YES

• Personal Disclosure YES

(Tax Returns)

• U.S. Estate Gift Tax YES

18 -40%

(Value in excess of $60,000)

• U.S. Income Tax YES

• Operating Income Tax Rate 20%

• Passive Income (no tax treaty country)

• Interest Tax Rate 30%

• Dividends Tax Rate 30%

• U.S. Capital Gains Tax Tax Rate 15-20%

• Tax Planning Techniques Moderate

• Branch Tax NO

29


LIMITED LIABILITY COMPANY

• Personal Liability NO

• Personal Disclosure YES

(Tax Returns)

• U.S. Estate Gift Tax YES

18 -40%

(Value in excess of $60,000)


• Operating Income Tax Rate 20%



• Dividends Tax Rate

30%

• U.S. Capital Gains Tax Tax Rate 15-

20%

• Tax Planning Techniques Moderate

• Branch Tax NO

30


U.S. CORPORATION


• Personal Disclosure NO(Tax Returns)

• U.S. Estate Gift Tax YES 18-40%* Value in excess of $60,000 NO GIFT TAX


• Operating Income Tax Rate 21%(plus state income tax)




• U.S. Capital Gains Tax Tax Rate 21%(plus state income tax)

• Tax Planning Techniques Moderately better than Indv.

• Branch Tax NO

31


FOREIGN CORPORATION


• Personal Disclosure NO(Tax Returns)

• U.S. Estate Gift Tax NO(Value in excess of $60,000)


• Operating Income Tax Rate 21%(plus state income tax)




• U.S. Capital Gains Tax Tax Rate 21%(plus state income tax)

• Tax Planning Techniques Improved

• Branch Tax YES

32

United States Taxation of

Foreign Real Estate Investors

Richard S. Lehman, Esq.

1900 Corporate Blvd., Suite 301W

Boca Raton, FL 33431

Tel: 561-368-1113

www.LehmanTaxLaw.com

33


Baker McKenzie │ Miami

Michael Melrose & Paul O'Quinn

US Real Estate Investments – A Guide for Foreign InvestorsDecember 17, 2019

34

© 2019 Baker & McKenzie LLP 35

▪ Income tax residency and estate/gift tax residency

▪ US Estate Tax

▪ US Income Tax

▪ FIRPTA withholding

▪ Section 163(j) business interest deduction limitation

▪ Portfolio interest exemption benefits

▪ Treaty application

▪ Other considerations:

▪ Consider State and Local issues

▪ Financing Considerations

▪ Succession Planning

Overview – tax rules that impact foreign investment in US real estate


US Real Property

Irrevocable

Excludible

Trust

Protected

The Basics – 40% US Estate Tax

Exposed

US Real Property

US Real Property

US Real Property

US Real

Property

US Real Property

Non-US

Corporation

US Corporation

Irrevocable

Excludible

Trust

Revocable Non-

ExcludibleTrust

Non-US

Entity CTB

Partnership

US LLC

Likely Protected?

US Real Property

Non-US

Partnership

US Real Property

US

Partnership

(Multi

Member LLC)


US Real Property

Irrevocable

Excludible

Trust

Corporate Taxpayer

The Basics – US Income Tax

Individual/Trust Taxpayer

▪ 21% Income Tax Rate

▪ 30% Branch Profits on "Dividend Equivalent

Amount" for Non-US Corporation and 30%

Dividend Withholding Tax from US Corporation

▪ Both 30% can be avoided with complete

liquidation and exit (but not necessarily on

operational income).

US Real PropertyUS Real Property


▪ Top Ordinary Income Tax Rate of 37%, and potential 20% deduction to bring

effective rate on ordinary income to 29.6% (subject to potential limits).

▪ 20% Long Term Capital Gains Rate (25% for gains attributable to prior

depreciation deductions).

▪ 3.8% tax for US domestic non-grantor trust on net investment income.

Non-US

CorporationUS Corporation

Irrevocable

Excludible

Trust

PartnershipUS LLCUS Real

Property

Revocable Non-

ExcludibleTrust


US Real

Property

Irrevocable

Excludible

Trust

Subject to FIRPTA

The Basics – FIRPTA Withholding

Not Subject to FIRPTA

US Real Property

US Real

Property

US Real

Property

US Real

Property

Non-US

Corporation

US Corporation

Non-US

Irrevocable

Excludible

Trust

Non-US

Partnership

US LLC

US Real Property

Revocable Non-

ExcludibleTrust

Non-US Individual

US Real Property

Non-US Individual

US Real Property

US

Partnership

(Multi

Member LLC)

USIrrevocableExcludible

Trust


Personal Use Structures

100%

99%

1%

US

Partnership/LLC

1%

US Real

Property

US Real Property

99%

Non-US

Corporation

US

Partnership

LLC

US Real Property

Irrevocable

Excludible

Trust

US LLC

Non-US CTB

Partnership

Non-US

Corporation

US Real Property

US Corporation

Non-US Individual or

Trust

Non-US Individual

or Trust


▪ Set up the structure before you sign the purchase contract!

▪ Respect the formalities of the structure

▪ cash transfers per ownership

▪ maintain company formalities

▪ Should rent be paid for use of personal residence owned by entity/trust?

Personal Use Structures—highlevel checklist


▪ Direct gifts of US real property interests (or wholly owned US LLCs) subject to gift/estate tax?

▪ FIRPTA taxation & FIRPTA withholding can apply (even if no gain/no tax due) if non-US person is transferring USRPI

▪ Section 1446(f) withholding may apply if transferring partnership interests

▪ Liquidating corporate structures will generally be taxablein US

▪ US corporation contribution to non-US corporation is generally an inversion (i.e. non-U.S. corporation treated as U.S.)

▪ Local real estate transfer taxes (also consider mortgage balances and mortgage recording fees)

Changing Ownership Structures –Concerns

▪ US or Non-US (both)?

▪ Institutional or Fund,

Corporate, Family Office,

Individual?

▪ Treaty country residents?

▪ Location (US or Non-US)

▪ Type (commercial, residential,

hotel, apartment, condo)

▪ Development/Redevelopment

timeline

▪ Level of commitment

▪ Level of financing (if any)

▪ Expected hold timeline and

exit strategy (refinancing/cash

distributions)?

▪ "Dealer" income concerns?

▪ Personal use concerns?

▪ ERISA limitations (pension

investors)?

▪ Opportunity Zone

qualification?

▪ US tax and information filing

aversions

▪ Home country treatment of

structure

Identify

Investor(s)

Identify

Investment(s)

Determine

Structure Constraints

42

Using Debt in structuring inbound investment in US real property

43


▪ Low/No Home Country Tax and US Withholding Tax on Interest Payments

▪ Treaty or Portfolio Interest Exemption?

▪ 10% owner or "related party" controlled foreign corporation (CFC)?

▪ Get the Deduction for Interest Payments at the US Blocker Level

▪ 163(j): Electing Real Property Trade or Business Exception

▪ 267A: Avoid Payments to Hybrid Entities or in Hybrid Transactions

▪ Also Consider for Corporation Borrowers: BEAT & 385 "Funding Rule"

▪ - $500M (US group) gross receipts may implicate BEAT minimum tax

Optimizing Income Tax Planning with Debt

US Real Property

LoanLoan Non-US Lender US Corporation

(Borrower)

US Real Property

US

Irrevocable

Excludible

Trust

(Borrower)


▪ Low/No Home Country Tax and US Withholding Tax on Interest Payments

▪ Treaty or Portfolio Interest Exemption?

Optimizing Income Tax Planning with Debt Treaty Benefits or Portfolio Interest Exemption

LoanLoan Non-US Lender

US Real Property

US Corporation

(Borrower)

US Real Property

US

Irrevocable

Excludible

Trust

(Borrower)


▪ Without portfolio interest exemption or treaty: A payor withholds 30% of gross amount of "fixed or determinable annual or periodic" ("FDAP") income paid to foreign person.

▪ If applicable, then the portfolio interest exemption permits the interest payments to be exempt from the 30% mandatory US federal withholding tax on the gross basis.

Portfolio interest exemption--benefits


▪ Interest payments must not be paid:

▪ to a 10% owner

▪ to a CFC from a related person

▪ to a bank

▪ Documentation Requirements

▪ Obligation in "Registered Form"

▪ W-8BEN required from the lender

Portfolio interest exemption - requirements

© 2019 Baker & McKenzie LLP

Portfolio Interest Exemption

Independent 3rd

party shareholder

Voting

Shares

Low Value

Non-Voting Shares

High Value

Portfolio

Debt LoanIrrevocable

"Excludible"

US Trust

Non-US Individual /

Trust Lender

Portfolio

Debt Loan


Foreign

(Non-US)

Corporation

US Corporation

US

Irrevocable

Excludible

Trust

Check the Box?

(267A?)

49

Non-US Owner

US Corporation

(>50%)

/ U.S. Partnership


▪ Applicable tax treaty may provide relief for investor not qualifying for portfolio interest exemption

▪ Consider residence and limitation of benefits provisions of treaties

▪ Even if the portfolio interest exemption is available, even greater benefits may be achieved using treaties in certain cases.

▪ Possible to utilize a treaty to structure leveraged investment so that it mirrors an equity investment from an economic perspective, without sacrificing tax efficiency.

▪ Treaty benefits on dividend distributions from US corporation (and possible reduction / elimination of branch profits tax)

▪ Many income tax treaties that eliminate US withholding tax on interest paid from the US

Treaty application?



▪ 163(j): Electing Real Property Trade or Business Exception

Optimizing Income Tax Planning withDebt -163(j)

LoanLoan Non-US Lender

US Real Property

US Corporation

(Borrower)

US Real Property

US

Irrevocable

Excludible

Trust

(Borrower)


▪ General Rule: Related and non-related party business interest expense deductions capped at 30% of EBITDA from 2018 to 2021 and 30% of EBIT thereafter

▪ 2 main exceptions to the section 163(j) limitation:

▪ If total annual gross receipts are less than $25M

▪ w/ application of aggregation rules considering worldwide gross receipts

▪ Electing real property trade or business (i.e., any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage tradeor business)

Section 163(j) – General Rules


Section 163(j) – Electing Real Property Tradeor Business

53

▪ Once a taxpayer elects to be treated as an "electing real property trade or business," that election cannot be revoked.

▪ If a taxpayer makes this election, they must use depreciation schedules with slightly longer depreciation lives. For qualified improvements, residential, and office, the lives increase from 15/27.5/39 to 20/30/40).

▪ No 100% Bonus Depreciation

▪ Limitation applied both at taxpayer level and at level of intervening partnerships

▪ Key open questions with respect to election mechanics and attribution of partnership real property trade or business to partners and shareholders (e.g., in tiered partnership structures or where debt is incurred at upper level blocker).


▪ Facts:

▪ 1Co, 2Co, and 3Co are unrelated.

▪ 1Co owns 30% of the interests in Fund. 2Co owns 40% of the interests in Fund. 3Co owns 30% of the interests in Fund.

▪ Fund owns 100% of the interests in REIT, which owns real property within the meaning of section 856.

▪ Analysis

▪ None of 1Co, 2Co, or 3Co's proportionate interest in REIT exceeds 80%.

▪ Accordingly, under proposed regulations 1Co, 2Co, and 3Co cannot look through to the assets of REIT.

Section 163(j): Allocating Interest Expense, Ex.1

US Real Property

REIT

Fund

1Co 2Co 3Co

30% 30%40%


Section 163(j): Allocation of InterestExpense, Ex.2

55

▪ Facts:

▪ 1Co and 2Co are unrelated.

▪ 2Co owns 90% of the interests in Fund. 2Co's adjusted basis in its partnership interest is $225.

▪ 2Co also operates a non-excepted trade or business ("NEToB"), whose assets have an adjusted basis of $112.50.

▪ 2Co paid or accrued $150 of interest expense allocable to a trade or business.Corp

Fund

1Co 2Co

10% 90%

NEToB

AB = $112.50

Interest

Expense = $150

NEToBRPToB

AB = $500 AB = $500

AB = $1000


▪ Analysis:

▪ Because 2Co owns greater than 80% of Fund's capital or profits, and Fund owns greater than 80% of the interests in Invest Co., 2Co must look through to the assets of Corp.

▪ 50% of Fund's adjusted basis in Invest Co is allocable to a non-excepted trade or business, and 50% of Fund's adjusted basis in Invest Co is allocable to an excepted trade or business (RPTOB).

▪ Therefore, 50% of 2Co's adjusted basis in Fund (or $112.50) is allocable to a non-excepted trade or business and 50% of 2Co's adjusted basis in Fund (or $112.50) is allocable to an excepted trade or business.


Invest Co

Fund

1Co 2Co

10% 90%

NEToB

AB = $112.50

Interest

Expense = $150

NEToBRPToB

AB = $500 AB = $500

AB = $1000


▪ Facts:

▪ 2Co's total adjusted basis in assets equals $337.50.

▪ $225 ($112.50 of partnership interest adjusted basis + $112.50 of 2Co standalone adjusted basis) is allocable to non-excepted trades or businesses.

▪ $112.50 ($112.50 of partnership interest adjusted basis) is allocable to excepted trades or businesses.

▪ Therefore, $100 ($225/$337.50 x $150) of 2Co's interest expense is subject to section 163(j), and $50 ($112.50/$337.50 x $150) of 2Co's interest expense is not subject to section 163(j).


Invest Co

Fund

1Co 2Co

10% 90%

NEToB

AB = $112.50

Interest

Expense = $150

NEToBRPToB

AB = $500 AB = $500

AB = $1000



▪ 267A: Avoid Payments to Hybrid Entities or in Hybrid Transactions

Optimizing Income Tax Planning with Debt Section 267A

US Real Property

LoanLoanUS Corporation

(Borrower)

US Real Property

US

Irrevocable

Excludible

Trust

(Borrower)

Hybrid

Lender(different treatment under

local law & U.S. tax)

Hybrid

Lender(different treatment under

local law & U.S. tax)


Optimizing Income Tax Planning with Debt Section 267A – General Rules

• Applies if “disqualified related party amount” paid or accrued by or to a “hybrid entity”

(or pursuant to a hybrid transaction).

• Key definitions:

• Disqualified Related Party Amount

• Payee controls or is under control of payor or same persons that control payor

(50% threshold)

• Not included in income in foreign country (or deduction allowed with respect to

such amount)

• Hybrid Entity – Transparent for U.S. tax, but not foreign country (or vice-versa).

• Hybrid Transaction – Interest for U.S. tax, but not foreign country

59


Optimizing Income Tax Planning with DebtBEAT & 385 (for U.S. C corporation borrowers)

▪ Also Consider for Corporation Borrowers: BEAT & 385 "Funding Rule"

▪ 385 Funding Rule

▪ Under these equity re-characterization rules, debt is re-characterized as equity in the event of specified distributions or acquisitions involving related parties and these debt instruments.

▪ Basically, distribution of those debt instruments to a shareholder, exchange of the instruments for affiliate stock, issuance of these debt instruments in an internal asset reorganization, or issuance of these instruments with a principal purpose of funding any of the above transactions

▪ $50M Exception & Grandfather rules.

▪ current per se “funding” rule to be modified per ANPR and modified to “significant factual connection” test

▪ - $500M (US group) gross receipts may implicate BEAT minimum tax

▪ Aggregation test for $500M gross receipts looks at 50% commonality of ownership

▪ Also need 3% base erosion percentage – look for “BEAT” payments to 25% related parties.

Using REITs in structuring inbound investment in US real property

61


▪ Minimize or avoid corporate "double tax";

▪ Avoid Unrelated Business Income Tax ("UBIT") forUS exempts;

▪ Avoid US tax under FIRPTA rules (e.g., domestically controlled REIT stock sales and for qualified foreign pension funds);

REITS?


REIT Structures

REIT

Public

OP

Non-US

Investors

US

InvestorsLP

US Real Property

JV

REIT

US Real Property


▪ Foreign investors, particularly ones that are not used to paying tax (pension plans, sovereign wealth funds), pay so-called FIRPTA tax on the sales of direct or indirect interests in US real estate.

▪ Sales of DCR stock is not subject to this tax. §897(h)(2).

▪ Must exit by selling stock. Notice 2007-55.

▪ Tax applies even with investors from treaty countries since most treaties only exempt interest, ordinary dividends, and non-FIRPTA capital gains.

Why a Domestically Controlled REIT?


▪ US 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 US 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.

Overview of Business Limitations


▪ REIT must make required distributions to avoid corporate level tax.

▪ 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%.

▪ A REIT must have over 100 direct shareholders, which is generally satisfied for private REITs by specialty companies providing approximately 115-125 accredited investors for $1,000 of preferred stock each.

Overview of Business Limitations


▪ No § 1031 on exit

▪ Potential TRS tax

▪ REIT compliance costs

▪ Potential corporate tax if fail REIT rules

▪ No pass-through of net losses

▪ REIT prevents real estate professional partner from avoiding Section 1411 tax

▪ Additional Representations and Warranties are requiredon exit

▪ Closely held restrictions

What are the costs of a DCR?


No dealer property (i.e., no condos)

▪ Special REIT rules for hotels

▪ 100% prohibited transaction tax potential if sell before 2-year holding period (based on placed in service date)

▪ When only one partner wants to sell

▪ Potential haircut on price of selling stock

▪ Buyer must be REIT qualified and not cause "closely held" or "related party rent" problems.

Other Limitations in DCR structure


Qualified Foreign Pension Fund (QFPF) Exemption

▪ REIT capital gain dividends no longer subject to FIRPTA for QFPF

▪ This allows pension funds to avoid need to use "domestically controlled" REIT, although will likely still use a REIT to avoid ECI on operating income (generally converting to 30% withholding tax).

▪ Huge benefit because now a QFPF is no longer required to sell REIT stock as exit.

▪ Puts QFPFs at odds with other international investors who still need to sell Domestically Controlled REIT stock

Qualified Foreign Pension Fund (QFPF)Exemption


If a REIT holds real property, interests in partnerships holding real property, or shares in other REITs holding real property, the REIT is eligible to make a Section 163(j) RPTOB Election for all or parts of its assets.

▪ Real property for purposes of the safe harbor is defined by reference to Treas. Reg. § 1.856-10.

If "real property financing assets" constitute:

▪ 10 percent or less of the value of the REIT's total assets at the close of the taxable year, all of the REIT's assets are treated as assets of an RPTOB.

▪ What are real property financing assets? Personal property?

More than 10 percent of the value of the REIT's total assets at the close of the taxable year, the REIT must allocate interest expense, interest income, and other items of expense and gross income between the RPTOB(s) (an excepted trade or business) and non-RPTOB election eligible businesses (a non-excepted trade or business)

REITS and section 163(j)

Big Picture Goals

Minimize Worldwide ETR

US Estate Tax Exposure?

US Income Tax • Deferral (e.g., 1031)

• Exclusions (e.g., O Zone)

• Tax rates (LTCG) and net

income planning (interest

deductions)

• UBTI concerns?

Home Country TaxTreatmentconsider applicable

tax treaties

Non-Tax Goals• ERISA issues?

• Personal Use

• Simplicity

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Documents

Foreign Investment in U.S. Real Estate: Portfolio Interest ...media.straffordpub.com/products/foreign-investment... · 12/17/2019 · Richard works with other lawyers, accountants,