The Need to Eliminate FIRPTA
NEW YORK CITY—In my last two blog posts, I have been critical of the government on New York City property taxes and the proposed reduction of the 1031 exchange. For a change, I wanted to voice my support for a potential tax revision regarding the Foreign Investment in Real Property Tax Act (FIRPTA). This tax would greatly boost foreign investment in US properties, and lead to job creation, stimulation of the economy and further increase property values.
On March 29th, President Obama released major proposals to encourage private investment in US infrastructure as part of a proposed Rebuild America Partnership. For international investors, the most significant aspect is to reform the FIRPTA rules that tax non-US investors on US real estate gains.
According to the IRS website, the disposition of a US real property interest by a foreign person (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. The transferee must deduct and withhold a tax equal to 10% of the total amount realized. A foreign corporation that distributes a US real property interest must withhold a tax equal to 35% of the gain it recognizes on the distribution to its shareholders.
Demetri Yatrakis, an international tax specialist at Weiser Mazars, said the amount can be adjusted pursuant to a withholding certificate issued by the IRS prior to closing. Sellers to a foreign person or entity, who fails to withhold, may be held liable for the tax.
In the early 1980s, with overseas investors hovering over American farmland and commercial properties, Congress set in motion the FIRPTA in an attempt to limit foreign acquisition of US real estate. I think we can all agree that today we would like to encourage foreign investment, as opposed to blocking it.
Foreign investment comprised slightly less than 10 percent, or $35.9 billion, of total US commercial real estate transaction volume in 2013, according to data cited from Real Capital Analytics. This is up $10 billion dollars from 2012 or about 16.5% in percentage. Massey Knakal’s website tracks foreign interest from 131 different countries. By relaxing or eliminating FIRPTA, this would certainly pave the way for further foreign investment.
Tax considerations do have a major impact on property valuations. One global investor told me that in London and Hong Kong, the tax on rental profit and capital gains to non-resident owners is substantially lower than in New York City. By way of rough comparison, taxes on rental profit in Hong Kong and London are approximately 15% and 20% respectively, while capital gain taxes are 15% in Hong Kong and virtually none in London for a non-UK resident. When one compares these tax levels to US federal tax requirements (39.6% on rental profits after allowable deductions and 20% on capital gains), higher cap rates and yields need to be sought after in the US to offset this tax.
There are other factors which drive lower cap rates in markets like Hong Kong, such as expected rental growth, which are also worth noting.
A vote has not yet been scheduled on this proposal, but similar legislation proposed in 2010 passed through the House of Representatives before falling by the wayside in the Senate. This is an initiative that the real estate community should get behind.