Provided by Real Estate Roundtable, rer.org
End-of-year real estate tax legislation
A little after midnight this morning, Congressional leaders released the full text of the Protecting Americans from Tax Hikes Act of 2015. The bill represents a major victory for TPAC on several Real Estate Roundtable priorities. I expect the House will vote on the tax bill on Thursday and the full “omnibus” budget on Friday. It then goes to the Senate (as a package), where the debate could stretch into the weekend, depending on the dynamics. However, I believe these provisions will be enacted into law within the next 5 days. Below is a summary of four provisions in the PATH Act critical for U.S. commercial real estate, followed by a short run-down on the other 24 real estate-related provisions:
- Expansion of FIRPTA “portfolio investor” exception: The PATH Act increases the ownership stake that a foreign investor can take in a U.S. publicly traded REIT without triggering FIRPTA liability on the sale of stock or capital gains dividends. Specifically, it increases the FIRPTA exemption for investors in a U.S. publicly traded REIT from 5 percent to 10 percent. This change brings the FIRPTA regime in line with the definition of a portfolio investor used in most U.S. tax treaties, as well as the statutory definition of a portfolio investor, as it applies to foreign investment in U.S. debt securities. The PATH Act also extends the portfolio investor exception to interests in REITs held by certain widely held, publicly traded, foreign collective investment vehicles. Together, these provisions will allow foreign investors to increase dramatically their investments in publicly traded U.S. REITs without exposure to FIRPTA. These changes apply to dispositions and distributions by a REIT on or after the date of enactment (provided the distribution is treated as a deduction by the REIT for a taxable year ending after the date of enactment). Revenue estimate: $2.297 billion / 10 years.
- Foreign pension fund exemption: The PATH Act completely exempts “qualified foreign pension funds” and entities wholly owned by such funds from FIRPTA taxation. The foreign pension exemption was further modified over the last week to clarify that the FIRPTA exemption applies to real estate held indirectly by a foreign pension fund through a partnership, as well as REIT capital gains distributions received by a foreign pension fund. A qualified foreign pension fund is defined as any trust, corporation, or other organization or arrangement that meets five requirements: (1) it is created or organized outside of the United States, (2) it is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or persons designated by such employees) of one or more employers in consideration for services rendered, (3) it does not have a single participant or beneficiary with a right to more than five percent of its assets, (4) it is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates, and (5) it enjoys tax benefits either with respect to contributions or investment income in its jurisdiction. The foreign pension fund exemption also eliminates FIRPTA withholding on real property sales by qualified foreign pension funds. The foreign pension fund exemption applies to dispositions and distributions after the date of enactment. Revenue estimate: $1.953 billion / 10 years.
- Determination of domestic control for FIRPTA purposes: The PATH Act also contains certain clarifying presumptions that will allow REITs and their shareholders to rely with greater confidence on the domestically controlled exception to FIRPTA taxation. Currently, gain resulting from the sale or disposition of stock of a domestically controlled REIT (i.e., a REIT, 50 percent of the stock of which is held by U.S. persons) is not subject to FIRPTA. In the past, it has proven difficult for many publicly traded REITs to take advantage of this exception comfortably, because they frequently lack the information needed to determine the domestic or foreign status of their “small” shareholders (i.e., those holding a less than 5 percent interest). The bill provides that a REIT that is publicly traded on a U.S. market may presume that all less than 5 percent shareholders are U.S. persons except where the REIT has actual knowledge to the contrary. Furthermore, stock in a REIT held by an upper-tier entity that is either a publicly traded REIT or a RIC meeting certain requirements will be treated as held by a foreign person unless the upper-tier REIT or RIC itself is domestically controlled. REIT stock held by any other type of upper-tier REIT or RIC will only be treated as domestically controlled to the extent that stock of the upper-tier REIT or RIC is held or is treated as held by a U.S. person. These reforms will afford both the Internal Revenue Service and foreign investors additional certainty as to the domestic status of an investment in both public and private U.S. REITs and the administration of U.S. tax law. These changes in the determination of domestic control are generally effective on the date of enactment. Revenue estimate: incorporated in portfolio investor provision.
- Permanent extension of 15-year straight-line depreciation for leasehold improvements, restaurants, and retail improvements: Leasehold improvements, or “build-outs,” are the structural changes made to leased space to make it suitable for a tenant’s specific business needs. They can include, lighting changes, technology upgrades, special rooms and partitions, and other changes to the interior of a building. The costs can be incurred by the building owner or the tenant. Leasehold improvements typically last for 5-10 years or less as tenants move out or their needs change. Prior law requiring taxpayers to depreciate leasehold improvements over 39 years was punitive, uneconomic, and discouraged building upgrades that improve the economic productivity of the built environment. In 2004, Congress adopted a temporary provision allowing taxpayers to depreciate leasehold improvements over 15 years. The PATH Act permanently extends the 15-year recovery period for qualified leasehold improvements, qualified restaurant property (new construction and improvements), and qualified retail improvement property. Cost: $20.3 billion / 10 years
The Real Estate Roundtable was heavily involved in the leasehold improvement provision when it was first adopted in 2004. Less than two years ago, the two (now former) chairmen of the Congressional tax-writing committees proposed eliminating 15-year depreciation for leasehold improvements altogether as part of their tax reform plans. In a short period of time, the debate turned 180 degrees, and it has been made a permanent part of the tax code.
In addition, the PATH Act includes over other 20 real estate-related provisions, many of which relate to real estate investment trusts. The other real estate provisions in the tax bill include:
- Permanent extension and modification of the increased expensing limitations in section 179, and elimination of the limit on use of the expensing allowance for qualified real property expenditures.
- Permanent extension of the temporary 9% minimum low-income housing tax credit rate for non-Federally subsidized buildings.
- 5-year extension of bonus depreciation (gradually phased down from 50% to 30%) and extension of the benefit to qualified nonresidential real estate improvements
- 2-year extension (through 2016) and modification of the exclusion from gross income for discharge of qualified principal residence indebtedness.
- 2-year extension (through 2016) of the treatment of mortgage insurance premiums as qualified residence Interest for purposes of the mortage interest deduction.
- 2-year extension (through 2016) of the section 45L manufacturer credit for energy-efficient new residential homes
- 2-year extension (through 2016) of the section 179D enhanced deduction for energy efficient commercial buildings with a modification (updating) of the energy efficiency standard.
- Restriction on tax-free spinoffs involving REITs. This provision was modified since its release last week and now includes transition relief for transactions that were already underway.
- A reduction in the percentage limit on assets of a REIT which may be taxable REIT subsidiaries (from 25 to 20 percent).
- Alternative 3-year averaging safe harbor for the REIT prohibited transaction tax
- Repeal of the preferential dividend rule for publicly offered REITs.
- IRS authority for alternative remedies to address certain REIT distribution failures.
- Limitations on designation of dividends by REITs.
- Treatment of debt instruments of publicly offered REITs and mortgages as real estate assets for asset test purposes.
- Treatment of ancillary property leased with real property as real property for REIT asset test.
- Asset and income test clarification regarding ancillary personal property.
- Expansion of REIT hedging provisions.
- Modification of the REIT earnings and profits calculation to avoid duplicate taxation.
- Expansion of services that a taxable REIT subsidiary can provide to the REIT.
- An increase from 10 percent to 15 percent in the FIRPTA withholding tax rate on dispositions of United States real property interests.
- Clarification that REITs and RICs cannot use the “cleansing exception,” which otherwise allows foreign shareholders to avoid FIRPTA if the REIT or RIC disposes of real property prior to distributing gain to the foreign owner.
- Clarification that dividends derived from RICs and REITs are ineligible for a deduction for the United States source portion of dividends from certain foreign corporations.
- Modification of the related-party loss rules to prevent loss shifting away from tax-indifferent parties
- Technical corrections related to the partnership audit rules enacted in the Bipartisan Budget Act of 2015, particularly with respect to publicly traded partnerships.
- [A provision included in last week’s 2-year tax extender “fallback” bill that would have disqualified certain rent that is based on a fixed percentage of receipts or sales from the REIT income test if it is derived from a single C corporation tenant was dropped from the legislation]
Additional Items including Incentives for Growth, Jobs, Investment, and Innovation:
- Extension and Modification of R&D Tax Credit.
- Extension and modification of increased expensing limitations and treatment of certain real property as section 179 property.
- Extension of new markets tax credit through 2019
- Extension and modification of bonus depreciation through 2019
- Extension of credit for energy-efficient new homes
- Extension of energy efficient commercial buildings deduction
- Updated ASHRAE standards for energy efficient commercial buildings deduction.