Last week, I blogged about PATH and the changes the legislation makes to the Foreign Investment in Real Property Tax Act (“FIRPTA”). One of the most important changes is that certain foreign pension funds are now exempt from FIRPTA when they dispose of U.S. real property. It was predicted that the exemption would increase the amount of foreign investment in U.S. real estate, and Canadian pension funds are already capitalizing on the change in the law: Canada’s largest pension fund, Canada Pension Plan Investment Board, recently announced its joint purchase of a $1.4 billion U.S. university student-housing portfolio with Scion Group LLC and Singapore’s GIC Private Ltd.
PATH also makes important changes to REITs. REITs are entities that own and often operate commercial real estate; sometimes REITs finance real estate. By investing in a REIT, an investor receives an opportunity to benefit from the income produced by commercial property, but he or she doesn’t have to purchase and manage the commercial property itself.
Here are five of the most important changes to REITs, now that PATH has been enacted:
First, as mentioned, foreign pension funds are now generally exempt from FIRPTA when they sell U.S. real property; distributions such funds receive from REITs are also FIRPTA-exempt.
Second, under PATH, a foreign investor can now own up to 10% of the stock of a publicly traded REIT that holds U.S. property, and those stocks will not be subject to FIRTPA. This is an increase from the 5% ownership that was previously allowed prior to PATH.
Another notable change that will affect corporate tax planning is that tax-free real estate transactions between a corporation and its subsidiary under Section 355 of the Internal Revenue Code (known as “spin-off transactions”) are now limited under PATH: corporations are generally no longer able to change the spun-out subsidiary into a REIT; the corporation must wait ten years after the date of the Section 355 transaction before a REIT election is made.
Additionally, prior to PATH, a REIT could avoid the potential application of the prohibited transaction tax if the percentage of property it sold in a year was no more than 10% of the value of its total assets at the start of the year; now, with some limited restriction, this safe harbor rule has been expanded to allow a REIT to dispose of up to 20% of its assets in a year while still avoiding the prohibited transaction tax.
Finally, as of the 2018 income tax year, a REIT may hold up to 20% of its assets in the form of securities of a taxable REIT subsidiary. This is a slight decrease from the previously allowable 25% maximum before the enactment of PATH.
These are just brief highlights of PATH and its impact on REITs. If you have questions about PATH, FIRPTA, or REITs, contact me at firstname.lastname@example.org. If you are already a foreign investor in commercial U.S. real estate through REITs or if you own U.S. real property in another structure, contact us to see how PATH and FIRPTA might affect you.