International Tax Conference©יקולים... · 2018. 5. 2. · International Tax Conference...

International Tax ConferenceTuesday | 1.5.18

Investments in US Real Estate – in Light

of the Tax Reform

Amir Chenchinski, Partner, US tax desk, EY

Saul Israel, Partner, ITS, EY

Itai Ran, Executive Director, US tax desk, EY

May 2018 Investments in US Real Estate

Common Investment Structure - Overview

Equity

US

LP

US

LP

US

LLC

Feeder

LP

Blocker

Feeder

LP

Corporate and institutional investors

Individual investors

Equity

Equity

LoansLoans

US real estate US real estate


Common Investment Structure – Effective Tax Rates

Agenda

► US reform

► Tax rates

► Corporate

► Individual

► Depreciation

► Bonus depreciation

► Real property business

► Estate tax

► Financing

► Section163(j)

► Anti-hybrid

► Portfolio Interest Exemption

► Qualified Foreign Pension Fund – REIT

► Israeli tax considerations

► REIT

► LLC treatment

ETRInvestor

~28%-30%Israeli individual

investors

~30%-33%Israeli corporate

investors

~20%Israeli

Institutional

Investors


US Tax Aspects – General


Tax Rates

► Corporate:

► 21% Federal (up to 35% until December 31, 2017).

► Individual:

► Note: Assuming assets are held for more then 3 years – “Promote” may qualify for

capital gains treatment.

2017 Tax brackets for married filing joint return

2018 Tax brackets for married filing joint return

The tax bracketsUp to an annual

profit

10%19,050$

12%77,400$

22%165,000$

24%315,000$

32%400,000$

35%600,000$

37%Over $ 600,000

The tax bracketsUp to an annual

profit

10%$ 18,650

15%$ 75,900

25%153,100$

28%233,350$

33%416,700$

35%470,700$

39.6%Over $ 470,700


20% Deduction - Section 199A

► 20% Deduction for individuals holding pass-through entities

► Pass-through entities (i.e. partnerships, LLC’s, S corps and REIT’s)

► Taxable ordinary (not capital) income.

► Deduction limitations

Pass-through

Taxable income 80

Taxable income 100

Tax rate bracket 37% ETR – 80*37%= 29.6

Taxable Income

Individual investorIndividual investor

US real estate


Bonus Depreciation

The new provisions inter alia are:

► 100% for qualified purchases made after September 17, 2017:

► 80% in 2023

► 60% in 2024

► 40% in 2025

► 20% in 2026

► Complete fade out by January 2027.

► Only eligible for corporations that use the Modified Accelerated Cost

Recovery System (MACRS) depreciation method.

► Now includes used property, as long as it is considered to be new in the

company's assets applying the depreciation.


Depreciation- Real Property Trade or Business Under IRC §163(j)

► Companies that elect to be treated as Real Property

Trade or Business under IRC §163(j), must depreciate

their assets under the ADS method:

► Qualified improvement property will not be eligible for

the Bonus Depreciation.

► Election irrevocable.

► Unclear as to how election is made.

MACRSADS

3940Non-residential rental property

27.530Residential property

1520Qualified improvement property

YESNOBonus Depreciation Qualification

LP

LLC

US LP

INC

Israeli

corporation

US real estate

RE Election out of 163(j)


Estate and Gift Tax

► Increase of annual exemption from taxation on gifts as well as the tax threshold for

estate tax for an interim period.

► Upon default, the legislation changes made to the tax liability threshold on Estate tax

will end by 2025.

► No change with respect to foreign persons.

Foreign person

Tax liability

threshold - over

Annual gift

tax

exemption to

a foreign

spouse

Estate tax

threshold

for couples

Estate tax

threshold

for

individuals

Annual Gift

Tax exemption

(per present)

Tax

Year

60,000$ (40% tax

for any excess

amounts)

148,000$10,900,000$5,450,000$14,000$2016

60,000 $ (40% tax

for any excess

amounts)

149,000$10,980,000$5,490,000$14,000$2017

60,000 $ (40% tax

for any excess

amounts)

152,000$22,400,000$11,200,000$15,000$2018


US Tax Aspects - Financing


IRC §163(j) – General Rule

► General rule: net interest expense (whether paid to a related party or to a third

party) may be deductible up to 30% of the taxpayer’s Adjusted Taxable Income

(“ATI”, ~EBIDTA through December 2021; ~EBIT starting January 2022).

► Disallowed interest is carried forward indefinitely and may be deductible in

succeeding taxable years subject to the limitations of §163(j) and §382.

► In the case of a consolidated group, the §163(j) limitation will generally apply at the level

of the consolidated group (rather than on a solo basis).

► In the case of a borrower partnership, the §163(j) limitation is determined at the

partnership level (rather than the partner level).

R/E

INC

INCINC

R/E

Consolidated group

JV

LLCLPLLC

100%100%100%

R/E R/E R/E

JV investing through disregarded entities

JV

LP

<100%

JV investing through partnerships

Determination is made at each partnership level

Determination is made at JV levelDetermination is made on consolidated basis

R/E

LP

R/E

LP

R/E

<100% <100%


IRC §163(j) – Double Counting Rule

► To prevent double counting, special rules are provided for the

determination of the ATI of each partner of the partnership.

► The ATI of each partner is determined without regard to such partner’s

distributive share of the partnership's profits or loss.

► On the other hand, if the partnership did not utilize the full amount

allowable under §163(j) (=30% of ATI), the partner may increase the

partner-level limitation amount by the pro rata share of the unused

amount.


IRC §163(j) – Double Counting Rule Example #1

Facts:

► US LP generates $200 of ATI and $60 interest expense.

► INC net taxable income = 0.

► INC interest expense = $25.

Application:

► US LP may deduct up to $60 (=30%*$200) of interest expense.

► US LP reports $140 ordinary business income.

► INC’s distributive share of US LP’s income is $70.

► INC has net taxable income of zero from its other operations. In

the absence of the double counting rule, INC’s $70 of taxable

income from its interest in US LP would permit the deduction of

up to an additional $21 of interest (30%* $70 = $21).

► The double counting rule provides that INC’s ATI computed

without regard to the $70 distributive share of US LP.

► INC has ATI of $0 – interest non deductible.

US LP

50%

Loan

Blocker

(INC)

LLCLP


Loan


IRC §163(j) – Double Counting Rule Example #2

Facts:

► As previous example, however, US LP has only $40

of business interest.

Application

► US LP has a limit on its interest deduction of $60.

► The excess amount for US LP is $20 (=$60- $40).

► INC’s distributive share of the excess amount from

US LP is $10.

► INC’s deduction for business interest is limited to 30%

of its ATI plus its distributive share of the excess

amount from US LP (30%*$0 + $10 = $10).

► INC may deduct $10 of business interest and has an

interest deduction disallowance of $15.

US LP

50%

Loan

Blocker

(INC)

LLCLP


Loan


IRC §163(j) – Exemption for Small Business

► $25M gross receipts (average prior 3 years)

► Aggregation rules between related parties may apply.

► One or more chains of corporations or partnerships with a common parent

corporation, or partnership that owns 50% of each of the corporations or

partnership, shall be aggregated.

► Generally, in case a borrower owns 50% or more in a partnership, the partner’s pro

rata share in the partnership's gross receipts shall be taken into account in

determining the $25M threshold at the level of the partner.

US LP 1

JV

60% 60% 60% 40% 40%

Gross receipts:

Net profits:

$ 20M

$ 0

$ 20M$ 0

$ 20M

$ 0

$ 20M

$ 0

$ 20M

$ 0

Each LP is entitled to the small business exemption

Gross receipts: $ 36M (=$20M *60%*3) Not entitled to the small business exemption

US LP 2 US LP 3 US LP 4 US LP 5


Electing Out of 163(j) – Real Property Trade or Business

► Real estate companies can elect out.

► Trade off: no one-time bonus depreciation.

US

LP

US

LP

US

LLC

Blocker

(INC)


Real property

trade or business

Real property

trade or business

Real property

trade or business

Real property

trade or business


Anti-Hybrid Rule

► In general, no deduction is allowed for any

“disqualified related party amount” paid or accrued

pursuant to a “hybrid transaction” or by, or to, a “hybrid

entity”.

► Disqualified related party amount – any interest or

royalty paid or accrued to a related party to the

extent that the related party does not include such

amount as income, or deducts the amount as

expense, under the tax law of the foreign

residence country.

► Hybrid transaction – payment treated as interest

or royalties for US federal tax purposes but

different classification for the tax law of the foreign

residence country.

► Hybrid entity – entity fiscally transparent for US

federal tax purposes but different classification

for the tax law of the foreign residence country; or

vice versa.

► The definition of hybrid entity is currently

limited to foreign entities.

Loan

Exempt Israeli institution

Israeli

corporation

Loan

LP LLC

IL LP

Blocker

(INC)

US

LP

Blocker

(INC)


US LP


Portfolio Interest Exemption

► Interest payments made by a US person to a foreign

person are subject to 30% withholding tax (reduced by

the US-Israeli tax treaty to 10% or 17.5%).

► Exemption from US withholding tax to “portfolio interest”

provided certain conditions are met.

► One of these conditions is that the interest is not

received by a CFC from a related person.

► In light of an amendment to the CFC attribution rule, any

non-US company which has a US affiliate (sister-brother

relationship) may be considered a CFC. Thus, such entity

may not be entitled to the Portfolio Interest Exemption if

the interest is received from a related person (generally,

more than 50% ownership).

► Note: under the language of the attribution rules, a non-

US parent company of a US subsidiary may be classified

as a CFC.

► Note: This interpretation is not consistent with

historic IRS Revenue Rulings which were published

with respect to different issues.

Israeli investor

Loan

>50%

>50%

US R/E US R/E

IL LP 2IL LP 1

Blocker 1

(INC)

Blocker 2

(INC)

LLCLLC

LP 1 LP 2


Opportunity: QFPF / REIT


Qualified Foreign Pension Fund Exemption

► Effectively an exemption from taxation with

respect to FIRPTA income.

► “Qualified foreign pension fund” - any trust,

corporation, or other organization or arrangement:

1. Created or organized under foreign law.

2. Established to provide retirement or pension

benefits to current or former employees for

services rendered.

3. With no single participant or beneficiary with a

right to more than 5% .

4. Subject to government regulation and

provides annual information to the relevant

tax authorities.

5. Contributions –

► are deductible or excluded from the

entity’s gross income or taxed at a

reduced rate; or

► Taxation of income is deferred or taxed at

a reduced rate.

US RH

Non QFPF

REIT

Vs

US real estate

US

LP

Loan Loan

QFPF


Qualified Foreign Pension Fund Exemption –Real Estate Investment Trust

► Effectively relevant only with respect to investments through REIT

► REIT Qualification Requirements:

a) REIT Ownership Tests:

1. A REIT must have at least 100 direct shareholders (this is a technical

requirement that for which compliance is easily achieved)

2. Five or fewer persons may not own more than 50% of the stock of a REIT

(applied on a “look-through” basis);

b) REIT Annual Income Tests

1. 75% income test

2. 95% income test

c) REIT Quarterly Asset Tests

1. 75%/25% asset tests

2. Limitations on Holding Securities [5% asset test, 10% asset (vote test), 10%

asset (value) test]

d) REIT Annual Distribution Requirement: 90% distribution test


Federal taxation of REIT - Advantage for QFPF and Individuals

Investor

Dividends Interest

Operating

Income

U.S. REIT

Distributions attributable to REIT’s sale of USRPIs

US real estate

Individuals QFPF

00Corporate Level

Tax

0% or 17.5%0% or 17.5%Interest

25%*30%Ordinary

Dividends

0%0%Return of Capital

~20%~0%Capital Gain

Dividends

20%0%Gain on Sale of

REIT Stock

* Assuming <10% shareholder


Qualified Foreign Pension Fund Exemption –Action Items

► Analysis of eligibility

► Analysis of existing and future investments and potential conversion

into REIT

► Maintain good REIT status


Israeli Tax Aspects


Points to Consider

► Leshem and Biran cases.

► ITA draft Circular (February 2018) – regarding classification of income from

rental of residential apartments, in light of the Leshem/Biran court ruling:

► Renting out up to 5 homes may be assumed to be passive.

► Renting out 10 or more homes should be classified as active business

operation.

► 5-9 rental units – should be tested based on general tests of “business”

► Relates to residential rentals only, not to commercial properties

► Reportable tax position 27/2016:

► An Israeli resident who derives profits from a foreign entity held more than

10% (directly or indirectly), must calculate taxable income in accordance

with the Israeli tax rules


Israeli Taxation of REIT Distributions

US

LP

Fund

LP

REIT

Corporate and institutional investors Individual investors

Equity

Equity

Loans

US real estate

► REIT may make distributions out of

profit, capital and/or capital gains

► Recent ITA ruling:

► Dividend distributions of profit

should be subject to tax as

ordinary business income (not

dividend)!!!

► Dividend distributions derived

from capital gains or return of

capital, should be treated as

capital gains. poses.


Taxation of REIT Distributions - ETR

Investor

Dividends Interest

Operating

Income

U.S. REIT

Distributions attributable to REIT’s sale of USRPIs

US real estate

ETR

Israeli taxUS tax

Corporate/

Individual

QFPFOther

investors

QFPF

0%N/AN/AN/A00Corporate

Level Tax

23% / 25%25%**23%0%*0% or

17.5%

0% or

17.5%

Interest

30% / 25% / marginal

rates

25% / Marginal

rates

23%0%*25%30%Ordinary

Dividends

0% / 23% /

25%

0% /

25%***

0% /

23%

0%*0%0%Return of

Capital

23% / 25%25%23%0%*20%0%Capital Gain

Dividends

23% / 25%25%***23%0%*20%0%Gain on

Sale of

REIT Stock

*Assuming section 9(2) ITO is applicable **Under certain conditions ***Assuming <10% shareholder


Israeli Tax Treatment of LLC’s

► ITA Circular 5/2004 allows allocation of income:

► Losses ring-fenced

► Management and control

► Reportable positions 14,15,16/2016 – guidelines for foreign tax credit,

including a restriction on use of losses from an entity which is not

transparent for Israeli tax purposes, but is transparent in the foreign

jurisdiction – similar to circular 5/2004 (LLC’s)

► Reportable position 50/2017:

► Circular 5/2004 is applicable only as regards foreign tax credit.

► No possibility to credit US tax paid against dividend income from the

LLC (assuming no election)


Israeli Tax Treatment of LLC’s

► Possible alternative – “house

company” (חברת בית)

► New legislation from 1.1.18,

expressly extends the application of

the rules (section 64 ITO) to foreign

entities which are transparent in

their local jurisdiction.

► Allows use of losses between

different LLCs which have all

elected status

► Control and management

LLC LLC

Israeli resident

individual

LLC

Elect “house company” status for each LLC

US real

estate

US real

estate

US real

estate

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International Tax Conference©יקולים... · 2018. 5. 2. · International Tax Conference...

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