structuring foreign investment in u.s. real estate: entity selection and transaction...

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Structuring Foreign Investment in U.S. Real Estate: Entity Selection and Transaction StructuresFIRPTA, Determining Individual vs. Entity Ownership Structures, Achieving Optimal Tax Treatment

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, MARCH 6, 2019

Presenting a live 90-minute webinar with interactive Q&A

William F. Griffin, Jr., Shareholder, Davis Malm & D'Agostine, Boston

Richard S. LeVine, Special Counsel, Withersworldwide, New Haven, Conn.

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Structuring Foreign Investment in U.S. Real Estate: Entity Selection and

Transaction Structures

William F. Griffin, Jr.Davis, Malm & D’Agostine, P.C.

One Boston PlaceBoston, MA 02108

www.davismalm.com

© 2019

CLASSIFICATION OF U.S. AND FOREIGN PERSONS

◼ “U.S. PERSON” (IRC §7701(a)(30)):A. a citizen or resident of the United States

B. a domestic partnership

C. a domestic corporation

D. any estate (other than a foreign estate)

E. any trust if –

i. a U.S. court is able to exercise primary supervision over the trust; AND

ii. one or more U.S. persons have the authority to control all substantial decisions of the trust

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◼ U.S. CITIZENS AND RESIDENTS (for income tax purposes):❑ U.S. Citizen

❑ U.S. Resident Alien (§ 7701(b))

A. “green card” test (§ 7701(b)(1)(A)(i))

B. “substantial presence” test (§ 7701(b)(3))

i. Present in U.S. for 183 days in calendar year; OR

ii. Present in U.S. for 31 days in current year AND

iii. Weighted average of 121 days during current and two prior years

iv. Weighted Average Formula: Current year x 100%Prior year x 1/3Next prior year x 1/6

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© 2019


◼ NON-RESIDENT ALIEN❑ An individual who is not a U.S. citizen or resident (§ 7701(b)(1)(B))

◼ DOMESTIC AND FOREIGN CORPORATIONS AND PARTNERSHIPS❑ Domestic Corporations and Partnerships:

◼ Organized under U.S. federal or state law (§ 7701(a)(4))

❑ Foreign Corporations and Partnerships:

◼ Organized under foreign (non-U.S.) law (§ 7701(a)(4))

❑ Foreign Trusts

◼ Foreign court supervision over trust; OR

◼ Foreign persons has authority to control one substantial decision

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◼ DOMESTIC AND FOREIGN TRUSTS❑ Domestic Trust (§ 7701(a)(30)(E))

◼ Subject to primary supervision of a U.S. court (the “Court Test”); AND

◼ Control of all “substantial” decisions” by U.S. persons (the “Control Test”). A trust with one foreign trustee controlling one substantial decision is a foreign trust.

◼ Regulations spell out “substantial decisions” (Treas. Reg §301.7701-7(d))

❑ Foreign Trust

◼ Any trust that is not a domestic trust (§ 7701(a)(31))

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U.S. TAXATION OF FOREIGN PERSONS

◼ U.S. INCOME TAXATION❑ U.S. Source Income includes:

◼ Rents of U.S. real and U.S. personal property

◼ Dividends from domestic corporation

◼ Interest paid by U.S. payor EXCEPT:

❑ Interest on U.S. bank deposits

❑ Interest on short-term debt (183 days or less)

❑ “portfolio interest”

◼ Gain on sale of U.S. real estate (but no other capital gain)

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◼ U.S. INCOME TAXATION❑ Character of U.S. Income

◼ Fixed and Determinable Periodic (“FDAP”) Income such as rent, dividends, wages and other remuneration

❑ An NRA is subject to a U.S. tax at a 30% flat rate on the grossamount of FDAP that is not connected with a U.S. trade or business.

❑ The tax is withheld at the source by the payor.

❑ The withholding tax may be varied by treaty with the country where the NRA is domiciled

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© 2019


◼ U.S. INCOME TAXATION ❑ U.S. Trade or Business Income

◼ U.S. source income that is “effectively connected” to a U.S. trade or business is taxed on a net basis under the same graduated income tax rates applicable to U.S. citizens (§ 871(b))

◼ Rental income may be classified as FDAP or “effectively connected” income, depending on the taxpayer’s level of business activity.

◼ Rents from “triple net” leases are FDAP; rents from an apartment building requiring active management by the taxpayer are usually considered as connected with a trade or business.

◼ Special net election under § 871(d) allows NRAs to treat real estate activities as a trade or business

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◼ Foreign Corporations

❑ Like domestic corporations, taxed at 21% on net income.

❑ Additional 30% “branch profits” tax on foreign corporation’s accumulated profits (§884 (a)).

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◼ FIRPTA WITHHOLDING❑ Sales and other taxable dispositions of “U.S. real property interests”

(USRPIs) by foreign persons are subject to withholding (§1445).

◼ The withholding rate is a percentage of the gross amount realized on the disposition:

❑ Zero for the disposition of a personal residence with a purchase price of $300,000 or less;

❑ 10% for amounts realized in excess of $300,000 but not in excess of $1 million;

❑ 15% for amounts realized in excess of $1 million.

◼ The seller must file IRS Forms 8288 and 8288-A to report the amount withheld and transmit the amount to the IRS within 20 days of the disposition.

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© 2019


◼ FIRPTA WITHHOLDING◼ Since the FIRPTA withholding amount is based upon the gross

purchase price of the real property, it will often exceed the amount of tax due on the transaction. The taxpayer may apply to the IRS on Form 8288-B to reduce the withholding amount to the taxpayer’s maximum tax liability with respect to the transaction.

◼ Unlike FDAP withholding, FIRPTA withholding amounts are available as credits against the taxpayer’s income tax liability for the year of sale

◼ Stock in a U.S. corporation with 50% or more of its fair market value in U.S. real property interests is a USRPI.

◼ Taxable dispositions of USRPIs include some capital contributions, entity distributions, merger transfers. Gifts of USRPIs are not taxable unless liabilities assumed (e.g., mortgages) exceed donor’s tax basis.

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◼ FOREIGN TRUSTS❑ A foreign trust is treated as a nonresident alien individual who is not present in

the United States at any time (§ 641(b))

❑ It is taxable on its income received from U.S. sources, at steeply graduated rates (the top tax rate of 37% applies to income in excess of $12,500)

❑ Like a domestic trust, a foreign trust is allowed a deduction for distributions to its beneficiaries

❑ If it is a “simple trust,” it is required to distribute all of its current income (§ 651(a)) It is allowed a deduction for all of its current income even if such distributions are not made; and all of the current income is passed through to the beneficiaries (§662(a)).

❑ If it is a “complex trust,” it is allowed a deduction for all current income required to be distributed or actually distributed, and the beneficiaries are taxed on such income (§§662(a), 667(d)). The excess income not distributed is taxable to the trust (at the steep rates noted above), and the beneficiaries are taxed again on the income distributed, but with a credit for the taxes paid by the trust (§667(d)(1)(A)).

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◼ GIFT AND ESTATE TAXATION ❑ THE IMPORTANCE OF DOMICILE

◼ Whether a person is a “U.S. resident” for estate and gift tax purposes is subject to a different test than that for income tax purposes.

◼ “A resident decedent is [one] who, at the time of his death had his domicile in the United States…A person requires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom.” (Treas. Reg. § 20.0-1 (b)(1)(b)).

◼ U.S. residents are subject to gift taxes and estate taxes on a worldwide basis, with a generous exemption of $11.18 million plus a marital deduction.

◼ A “nonresident not a citizen” (§§ 2101(a), 2501(a)(2)) is subject to gift taxation only on gifts of U.S. real estate, taxable personal property and cash, and to estate taxation only on tangible and intangible property located in the United States.

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© 2019


◼ U.S. GIFT TAX❑ A foreign national who is not a U.S. resident is subject to a U.S. gift tax

on gifts of U.S. real estate and tangible personal property; intangible property, such as corporate stock, are exempt.

❑ U.S. gift tax rates apply, and an annual exclusion of $15,000 is allowed ($30,000 for “split gifts”)

❑ An annual exclusion of $152,000 is allowed for gifts to a spouse who is a non-U.S. citizen (§ 2523(i)(2)); gifts to a spouse that is a U.S. citizen are unlimited in amounts.

❑ No unified credit is allowed to an NRA for gift taxes (§ 2102 (c)(3)(B)).

❑ Since gifts of “intangible property” by an NRA are not subject to the gift tax, that tax may be avoided by donation of stock or membership interests in corporations or LLCs owning real estate. Single member LLCs are not “disregarded entities” for gift and estate taxes under the Pierre case, but beware of “step transactions.”

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◼ U.S. ESTATE TAX❑ The gross estate of an NRA includes all tangible and intangible property

in the United States owned or controlled by the decedent.

❑ Unlike U.S. residents, who have an $11.18 million estate tax exemption, nonresident aliens have only a meager $60,000 exemption (§ 2102 (c)(1)), with no marital deduction for a nonresident spouse (§2056(d)).

❑ The current 2019 estate tax rates for estates in excess of $60,000 range from 24% to 40%.

❑ U.S. property included in a nonresident decedent’s estate includes U.S. real estate, corporate stock in a U.S. corporation, debt obligations of a U.S. person (with exemptions for bank deposits and “portfolio interest obligations”) (§§2105(b)(1), 2105(b)(2)). Life insurance proceeds are not included in a nonresident decedent’s gross estate (§2105(a)).

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Thank You!

One Boston PlaceBoston, MA 02108

www.davismalm.com

William F. Griffin, [email protected]

(617) 367-2500

Structuring Foreign Investment in US

Real Estate

Tax & Legal Considerations

for Non-US Investors

Strafford Continuing Education Webinar

March 6, 2019

Panelists:

William Griffin, Jr. – Davis. Malm & D’Agostine, P.C.

[email protected]

Richard LeVine – Withers Bergman

[email protected]

Some thoughts on Ownership Structuring

Common objectives include one or more of the following:

• Preserve anonymity (not buy in own name)

• Consider personal use (not pay rent)

• Insulate against US estate tax

• Insulate against US gift tax

• Minimize or eliminate US income tax on rental income

• Minimize or eliminate US income tax on sale of the property

• Minimize US tax filings

These objectives are addressed through ownership structuring…

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Ownership Individually

• Advantages

• Simplicity

• No additional entity tax return.

• Total control and ownership in NRA.

• Long-term capital gain tax rate of 20% applies if held for over 12 months.

• Disadvantages

• No privacy since NRA’s name listed on land register.

• All income (annual rental or capital gain at exit) is taxed to the NRA.

• Rental income subject to tax at rate up to 37% - but interest and depreciation

deductions often reduce or eliminate net income.

• No estate tax protection.

• No gift tax protection.

• Annual or periodic US tax filings would be by the NRA individually.

NRA

USRPI

24

Ownership Through Disregarded US LLC

• Advantages

• SMLLC provides property liability protection.

• SMLLC is disregarded for US tax purposes, so single level of income tax.

• FIRPTA will apply, assuming owner is NRA at the time of sale.

• Long-term capital gain tax rate of 20% applies if held for over 12 months.

• Disadvantages

• All income (annual rental or capital gain at exit) is taxed to the NRA.

• Rental income subject to tax at rate up to 37% - but interest and depreciation

deductions often reduce or eliminate net income.

• No estate tax protection.

• No gift tax protection.

• Annual or periodic US tax filings would be by NRA, individually.

• Local law treatment of the LLC should be confirmed (whether characterized as a

corporation or a flow-through entity).

NRA

US LLC

(disregarded)

USRPI

25

Ownership Through Single US Corporation

• Advantages

• No US gift tax on USCo share transfers. A gift of an intangible asset, such as

shares of stock or of a partnership interest, is not subject to gift tax.

•Expenses related to maintaining the property likely allowed if Form 1120 is filed.

• 21% tax rate (plus state income tax) on both rent and capital gain on property

disposition

•Can liquidate company after real estate is sold and no second level tax

• Disadvantages

• US estate tax on death (US corporations included in the US taxable estate)

• Stock is a USRPI; FIRPTA issue if stock is sold

•Filing of Form 1120 requires disclosure of 25% non-US owners and balance

sheet

•Filing of Form 5472 if check the box for USCo to be a disregarded entity. Form

requires name and US ID number of NRA to be obtained and reported.

NRA

USCo

USRPI

26

Ownership Through Single non-US Corporation

• Advantages

•Stock not a USRPI; no FIRPTA issue if stock is sold

•No US estate tax (foreign corporation shares are not included in the US taxable

estate)

•No US gift tax on ForCo share transfers.

•Expenses related to maintaining the property likely allowed if Form 1120F is

filed.


disposition

• Disadvantages

•Branch tax risk (30% on 79%) if corporation remains in existence after property

sale unless cash is re-invested in US trade or business or property

•Withholding on income at the highest marginal rate if investing via joint venture

•Filing of Form 1120F requires disclosure of 50% owners and balance sheet

NRA

ForCo

USRPI

27

Two-Tier Corporate Structure (“Corporate Sandwich”)

• Advantages


disposition

• Disposition of ForCo shares not subject to FIRPTA

• No US gift tax

• No US estate tax

• No US branch profits tax.

• Earning stripping possible with related party loans, but limited

• Disadvantages

• 30% dividend withholding tax (where Income Tax Treaty benefits are not available)

Cannot extract free cash from US Co. without 30% dividend tax until time of

liquidation

• 30% interest withholding tax (unless a reduced tax treaty rate applies) on related party

loans (10% ownership test)

• Must liquidate to avoid the dividend withholding tax

• Form 1120 US tax compliance requires identity of direct and indirect owners and

balance sheet disclosure.

NRA

ForCo

USCo

USRPI

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Two-Tier Corporate Structure – Multiple Properties

• Advantages

• Can liquidate each USCo when the relevant property is sold without second level tax

• More protection against a claim “tainting” entire portfolio

• Disadvantages

• Complexity

• Cost of multiple entities, multiple tax returns, etc.

• Cannot consolidate under ForCo.

NRA

ForCo

USCo 1

Property 1

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USCo 2

Property 2

Non-US Irrevocable Trust that Owns Disregarded Entity

US LLC

USRPI

• Advantages

• 20% long-term capital gains tax rate on gains from sale (plus state tax)

• Related party loans to trust permit 9:1 earnings stripping

• Can easily consolidate income and expenses from multiple projects for efficient offsetting

• No withholding required on related party offshore loans to trust, thus can extract free cash

without withholding tax.

• Ability to flip pre-full development property at LTCG rates with installment note

• No US tax filing requirement for foreign grantor or beneficiaries (absent disitributions)

• No balance sheet disclosure

• No US estate tax exposure (settlor will not be a beneficiary)

• No US gift tax

• No branch profits tax

• A single-member domestic LLC would be disregarded as an entity separate from its owner

for federal and state income tax purposes but would offer some limited liability protection and

a level of privacy.

• Personal use of property held in trust does not give rise to imputed income to the trust.

• Disadvantages

• 37% income tax on ordinary income (i.e., business and rental income) (plus state tax)

• 3.8% Medicare tax will apply to ordinary income (rental) unless trustee actively involved in

managing the property, but can be avoided with exit strategy planning.

NRA

US

Complex

Trust

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Summary ChartTrust with LLC Dual Corporation Individual with LLC

Capital gains tax rate on gain

20% 21% 20% (if over $400,000, 15% if less)

Medicare tax at 3.8% rate Not necessarily No No

Files tax returns in personal name

Not necessarily No but need to disclose foreign shareholders and related party transaction

Always

Excess interest expense carries forward to offset gain from sale.

Yes Yes Yes but limited

30% withholding tax on related party interest payments

No Yes unless treaty jurisdiction lender

No

Limits on deductibility of interest expense

Yes (less restrictive) Yes (more restrictive) Yes (less restrictive)

Estate tax protection Yes Yes No

Distribution creates additional withholding

No Yes No

31

NRA

Insurance CompanyForeign 953(d) Electing

Life Insurance

Contract(s)

Advantages

• No income tax on gains from property sale

• No income tax on rental income from properties

• No income tax on NRA receipt of insurance proceeds on death of insured

• Tax free access during insured’s lifetime by borrowing

• No US tax filing requirement by foreign grantor or beneficiaries

• No US gift tax


Disadvantages

• Must have at least 5 properties in policy

• Cannot control or manage properties-must use independent 3rd party

• Insurance costs (measured by Premium less amount paid for COI and M&E 100 bps)

• Cannot use property personally

• If complete withdrawal from investment, withholding on CSV minus premiums paid at 30% (can be managed with possible Section 1035 transfer)

Ownership Through Private Placement Variable Insurance Contract Blockers

32

Multiple USRPIs

Trust

Non-US Corporation

InsuranceCompanyForeign953(d) Electing

Deferred Variable Annuity

Advantages

• No income tax on gains from property sales

• No income tax on rental income from properties

• No US tax filing requirement by foreign grantor or beneficiaries

• No US gift tax


Disadvantages

• Must have at least 5 properties in DVA

• Cannot control or manage properties – must use independent 3rd party

• DVA costs (often < 50 bps )

• Withdrawals taxed at 30% without treaty

• Withdrawals must occur over schedule

• If complete withdrawal from investments withholding on accrued income at 30% (can be managed with possible Section 1035 transfer)

Ownership Through Deferred Variable Annuity Contract Blockers

33

Multiple USRPIs

NRA

LoanCoupon plus % Appreciation

US Real EstateHolding Venture

USRPI

Advantages

• US payor pays income tax on rental income and sales from properties

• No gift tax

• No estate tax

• NRA recipient at loan maturity may pay no income tax on repayment

Disadvantages

• Cannot control, manage or have greater than 10% ownership interest in holding venture or interest withheld at 30% (absent treaty)

• Cannot share in contingent appreciation without triggering withholding tax (absent treaty)

• Cannot use property personally

Ownership Through Shared Appreciation Mortgage

34

More On Shared Appreciation Mortgages

35

Regulation Section 1.897-1(h), Example 2

• Foreign corporation makes $1 million loan to domestic individual

which is secured by mortgage on real property purchased with loan

proceeds.

• Loan agreement entitles lender to fixed monthly payments,

constituting repayment of principal plus fixed interest rate.

• Lender also entitled to receive certain percentage of the

appreciation in value of real property at the time that the loan is

retired.

• Shared appreciation loan treated as U.S. real property interest

(USRPI), but receipt of final payments do not constitute

“disposition” of USRPI for purposes of Section 897.

• Example 2 concludes that Section 897 is not triggered on receipt of

final loan payment because payment constitutes principal and

interest, not gain for tax purposes.

Ownership Through Domestically Controlled REIT

REIT

NRA US Investors

> 100 Preferred Shareholders

USRPI

49% 51%

Advantages

• No income tax at REIT level with distributed income

• Dividend tax at 30% (lesser amount if treaty based NRA) on distributions

• Sale of domestically controlled REIT shares is tax free

Disadvantages

• REIT ownership and operations are complicated with multiple shareholders and investment limitations

• Domestically controlled REIT transfers management and control to US person

• US estate taxable asset

• Cash outs with REIT share sale may be limited

36

Section 1031: Like-Kind Exchanges

Like-Kind

• Most Fee Interests in Real Estate are Like Kind to

each other:

• Improved and Unimproved

• Residential and Commercial

• Leases of 30+ years are Like Kind to Fee Interests

16

Section 1031(h)

•U.S. real estate not like kind to non-U.S. real estate

Therefore, cannot escape U.S. taxation by exiting through exchange

of U.S. property for non-U.S. property

•Foreign for Foreign is still allowed

Would be U.S. tax relevant only for U.S. resident taxpayer

17

Portfolio Interest

• U.S. source interest paid to a foreign person

that is not ECI is subject to 30 percent tax

• Tax collected via withholding at source.

• However, Sections 871(h) and 881(c) provide

that interest that qualifies as "portfolio interest"

is exempt from U.S. taxation

• Debt instrument must be in registered form

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Portfolio Interest

• Does not apply if amount of interest is

contingent on sales, cash flow, income, profits or

change in value of debtor’s property

• Does not apply if lender is 10-percent voting

shareholder of issuing corporation or 10-percent

owner of capital or profits interest in issuing

partnership.

• •For this purpose, Section 318 attribution rules

apply to determine ownership, including Section

318(a)(4) option attribution rule

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Portfolio Interest

• However, there is an exception to the contingent interest rule

for:

• Any amount of interest determined by reference to

• (I) changes in the value of property (including stock) that is

“actively traded” (within the meaning of section 1092(d))

other than property described in section 897(c)(1) or (g))

(i.e., USRPIs and interests in partnerships, trusts, or

estates that are considered USRPIs),

• (II) the yield on property described in subclause (I), or

• (III) changes in any index of the value of property described

in subclause (I) or of the yield on property described in

subclause (II).

• Therefore, interest paid to a foreign person that is contingent on

one of the above factors will be exempt from the 30 percent

U.S. withholding tax (regardless of the existence of a treaty).

20

Portfolio Interest

NRA

ForCo 1

USCo

USRPI

NRA’s sibling

ForCo 2

9% vote

99% equityLoan

Portfolio

Interest91% vote

1% equity

21

Treaties – Derivative Benefits

• Most U.S. tax treaties have “limitations on benefits” (LOB)

provisions that limit the ability of companies to obtain treaty

benefits unless the company is publicly traded or mostly

owned by U.S. and/or local country resident individuals

• Many treaties concluded with the United States that have

LOB provisions contain a “derivative benefits” clause in such

provision.

• •Under such provision, a company that qualifies as a

“resident” for treaty purposes, but fails to qualify under the

LOB provision because of ownership by third country

residents, may still qualify for treaty benefits if the third

country owners are “equivalent beneficiaries.”

22


• To qualify as an equivalent beneficiary, the following factors

typically must be satisfied:

• (i) there is a tax treaty between the equivalent

beneficiary’s country of residence and the United States,

• (ii) the equivalent beneficiary would be entitled to benefits

under that treaty if it invested directly in the United

States, instead of through the treaty company, and

• (iii) in the case of interest, dividends, and royalties, the

treaty between the United States and the equivalent

beneficiary’s country of residence must provide a

withholding rate that is “as least as low” as the rate

available under the treaty claimed.

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• In addition, the equivalent beneficiary typically must be

resident in:

• A European Union (EU) jurisdiction,

• A European Economic Area (EEA) jurisdiction,

• A jurisdiction that is a party to the North American Free

Trade Agreement (NAFTA),

• Switzerland, or

• Australia (in the case of Malta treaty)

24


Example: Assume FCo, a French company, wholly

owns a U.K. company (UKCo), which in turn wholly

owns a U.S. company (USCo). With respect to

dividends, the U.S.-U.K. treaty has (i) no

withholding for 80-percent-or greater corporate

owners, (ii) 5 percent withholding for 10-percent-or-

greater corporate owners, and (iii) 15 percent in all

other cases. Under the U.S.-French treaty, the

lowest withholding rate on dividends is 5 percent.

Despite the fact that U.S. has treaty with France (a

member of the EU), and FCo would be entitled to

treaty benefits under the U.S.-France treaty, FCo is

not equivalent beneficiary because the withholding

rate on dividends under U.S.-France treaty (5

percent) is not as low as lowest withholding rate

under U.S-U.K. treaty. Thus, dividends paid from

USCo to UKCo not eligible for 0 percent rate.

NRA

French Co

UK Co

US Co

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Some parting thoughts on the reorg provisions…

• ‘‘Nothing in FIRPTA is clear.’’

• “In the end, significant portions of the original regulatory language are no longer applicable, and many of the other rules set forth in the regulations come with exceptions and with exceptions to exceptions that appear only in the notices or notices that modify other notices.”

• David F. Levy in “Nonrecognition Transactions Involving FIRPTA Companies”

• “more often than not, when the tax advisor consults the regulations and Notices for an answer to a FIRPTA question, she finds no answer, finds a partial answer that cannot be clearly applied to the facts at hand, or finds an answer that is clearly ridiculous under the circumstances.’’

• Kimberly Blanchard in ‘‘FIRPTA in the 21st Century — Installment One: A Closer Look at Reg. § 1.897-5T(c),’’

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What is the Branch Profits Tax

• A dividend equivalent for accumulated earnings. It is an

extra income tax on foreign corporations which earn profit

from US investments or US business operations.

• Imposed on a non-US corporation’s after-tax net profit.

(30% tax is applied on after-tax net income as the branch

profits tax). Reported directly on Form 1120F

• Intended to cause non-US corporations (and their

shareholders) to be taxed identically to US corporations

(and their shareholders).

27

Impact of the "branch profits tax"

• overall effective U.S. tax rate on a foreign corporation doing

business in a state (such as New York and California) with

relatively high corporate income tax can rise to approximately

61% [i.e., 42% + (30% x 58%)] during its operating phase.

• BPT is imposed at the rate of 30% on the after-tax U.S. profits of

the foreign corporation from a U.S. trade or business.

• BPT may be eliminated or reduced, though, when the foreign

corporation is organized in a favorable U.S. treaty country

• treaty overrides or limits the branch profits tax when the treaty-

based corporation is more than 50% owned by residents of that

treaty country (or USPs).

28

Branch Profits Tax Can be avoided if:

• Reinvest your profits in the United States;

• Exemption in income tax treaty; or

• Completely terminate all business and investment

operations in the United States (i.e., sell assets then

liquidate the US sub).

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Branch Profits Tax on Real Estate

• The branch profits tax is essentially harmless to nonresident real

estate investors if

• one piece of U.S. real estate

• that property is not producing income.

• The branch profits tax will apply to nonresident investors in U.S.

real estate who have rental income held directly by a non U.S.

corporation. The income collected (after expenses) will be

subjected to the BPT.

• This is a problem if a single US corporation holds multiple

properties, since sale of one property will generate income, but

the US subsidiary cannot be liquidated since it holds multiple

properties.

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Situs of Partnership Interests – Income Tax

• Section 864(c)(8) provides that sale of partnership interest

creates US source gain to the extent the partnership was

engaged in trade or business in the US at the time of sale.

• FIRPTA gain from sale of interest in a partnership that is a USRPI

is excluded as this was already made taxable under Section 897

• Query whether Section 864(c)(8) generates any implications for

the situs of the partnership interest for gift and estate tax

purposes

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Situs of Partnership Interests – Estate and Gift Tax

• Treas. Regs. § 20.2104-1(a)(4) addresses situs of corporate

stock and bond interests turns on the place of incorporation of the

issuer or obligor.

• An entity approach. Analogous rule for a partnership would be:

• If organized in the United States, its equity and debt interests will

have a U.S. situs

• If organized outside the United States, its equity and debt interests

are non-U.S. situs.

• Planning point: ensure that the foreign partnership is regarded

(under local, foreign law) as an entity separate from its partners

and that the death of the partner in question does not terminate

the partnership.

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Situs of partnership interests – Estate and Gift Tax

• Case law and commentary seem to support entity over aggregate theory.

But there are still two possible outcomes:

• Situs is determined based on the location where the partnership

conducts its business, following Rev. Rul. 55-701 (1955)

• Situs is determined based on the residency of the partnership for

income tax purposes (i.e., its place of organization) following Reg.

301.7701-5, which is consistent with the rules applied to

corporations under Section 2104(a) and Reg. 20.2104-1(a)(5). See

Pierre v. Commissioner, 133 T.C. 24 (2009).

At this point, there is no clear rule.

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SALT:

conveyance, transfer tax or stamp duty ( synonymous)

• Grant of a lease of less that 50 (in practice 48.5) years in

NY is not subject to the NYS transfer tax

• Surrender of a lease (of any length) is subject to the NYS

transfer tax

• Leases with purchase options in NY are deemed to be

sales and subject to the full tax, even if the option is never

exercised.

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SALT … matters

• New York state individual/trust tax rate: 8.82%

• New York City individual/trust tax rate: 3.88%

• New York State + City combined: 12.7%

• New York State + City corporate income tax (whether US or non-

US) levied one of four ways. One is a minimum tax. Two are

based on income. The fourth is based on a “capital base” based

on net asset value so that a corporation could be stuck with an

annual income tax based on the value of its assets.

• California individual/trust tax rate: 13.3%

• California corporate income tax rate: 8.84%

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structuring foreign investment in u.s. real estate: entity selection and transaction...

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