Foreign Investment in U.S. Real Estate: Portfolio Interest...
Transcript of Foreign Investment in U.S. Real Estate: Portfolio Interest...
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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
FOR LIVE PROGRAM ONLY
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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
Michael D. Melrose, Attorney
Baker & McKenzie
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
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
TAX ATTORNEY: Richard S. Lehman, Esq • Tel: 561-368-1113 • www.LehmanTaxLaw.com
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
TAX ATTORNEY: Richard S. Lehman, Esq • Tel: 561-368-1113 • www.LehmanTaxLaw.com
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
Investment and Tax Objectives
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
Investment and Tax Objectives
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
Investment and Tax Objectives
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
Investment and Tax Objectives
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
Maximum Use of Investment Entity
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)
• 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
30
Maximum Use of Investment Entity
U.S. CORPORATION
• Personal Liability NO
• Personal Disclosure NO(Tax Returns)
• U.S. Estate Gift Tax YES 18-40%* Value in excess of $60,000 NO GIFT TAX
• U.S. Income Tax YES
• Operating Income Tax Rate 21%(plus state income tax)
• Passive Income (no tax treaty country)
• Interest Tax Rate 30%
• Dividends Tax Rate 30%
• U.S. Capital Gains Tax Tax Rate 21%(plus state income tax)
• Tax Planning Techniques Moderately better than Indv.
• Branch Tax NO
31
Maximum Use of Investment Entity
FOREIGN CORPORATION
• Personal Liability NO
• Personal Disclosure NO(Tax Returns)
• U.S. Estate Gift Tax NO(Value in excess of $60,000)
• U.S. Income Tax YES
• Operating Income Tax Rate 21%(plus state income tax)
• Passive Income (no tax treaty country)
• Interest Tax Rate 30%
• Dividends Tax Rate 30%
• 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
© 2019 Baker & McKenzie LLP 36
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)
© 2019 Baker & McKenzie LLP 37
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
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
© 2019 Baker & McKenzie LLP 38
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
© 2019 Baker & McKenzie LLP 39
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
© 2019 Baker & McKenzie LLP 40
▪ 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
© 2019 Baker & McKenzie LLP 41
▪ 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
© 2019 Baker & McKenzie LLP 44
▪ 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)
© 2019 Baker & McKenzie LLP 45
▪ 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)
© 2019 Baker & McKenzie LLP 47
▪ 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
© 2019 Baker & McKenzie LLP 48
▪ 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
US Real PropertyUS Real Property
Foreign
(Non-US)
Corporation
US Corporation
US
Irrevocable
Excludible
Trust
Check the Box?
(267A?)
49
Non-US Owner
US Corporation
(>50%)
/ U.S. Partnership
© 2019 Baker & McKenzie LLP 50
▪ 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?
© 2019 Baker & McKenzie LLP 51
▪ Get the Deduction for Interest Payments at the US Blocker Level
▪ 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)
© 2019 Baker & McKenzie LLP 52
▪ 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
© 2019 Baker & McKenzie LLP
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).
© 2019 Baker & McKenzie LLP 54
▪ 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%
© 2019 Baker & McKenzie LLP
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
© 2019 Baker & McKenzie LLP 56
▪ 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.
Section 163(j): Allocation of InterestExpense, Ex.2
Invest Co
Fund
1Co 2Co
10% 90%
NEToB
AB = $112.50
Interest
Expense = $150
NEToBRPToB
AB = $500 AB = $500
AB = $1000
© 2019 Baker & McKenzie LLP 57
▪ 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).
Section 163(j): Allocation of InterestExpense, Ex.2
Invest Co
Fund
1Co 2Co
10% 90%
NEToB
AB = $112.50
Interest
Expense = $150
NEToBRPToB
AB = $500 AB = $500
AB = $1000
© 2019 Baker & McKenzie LLP 58
▪ Get the Deduction for Interest Payments at the US Blocker Level
▪ 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)
© 2019 Baker & McKenzie LLP
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
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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
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▪ 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?
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REIT Structures
REIT
Public
OP
Non-US
Investors
US
InvestorsLP
US Real Property
JV
REIT
US Real Property
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▪ 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?
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▪ 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
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▪ 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
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▪ 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?
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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
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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
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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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