Foreign Investment in U.S. Real Estate: Portfolio Interest Exemption and IRC 163(j) Interest Limitations

Description

The 2017 tax reform legislation indirectly provided significant benefits for foreign investors in U.S. real estate. Tax advisers to non-U.S. clients with U.S.-situs real property must be conversant with the specific tax advantages for this type of investment to avoid costly consequences.

Foreign individuals and corporations will continue to face tax liability and withholding requirements under the existing FIRPTA rules on their dispositions of U.S. real property interests. While the tax reform law did not materially change the FIRPTA structure, the Act lowered the FIRPTA withholding rate on capital gain dividends and liquidating distributions paid by REITs to align with the reduced top corporate tax rate of 21% provided in the new law.

A significant benefit available to foreign, but not U.S., investors in U.S. real estate is the portfolio interest exemption. The new business interest deduction limitation found in Section 163(j) enhances the value of this exemption to non-U.S. investors. The long-standing provision allows blocker corporations to bypass the 163(j) limitations in deducting interest expenses paid to a non-U.S. lender on a registered debt, as well as avoiding the 30% federal withholding tax on U.S.-sourced income.

Tax advisers must adhere to the election and documentation requirements to qualify for the portfolio interest exemption. The ability to avoid 163(j) limits will influence the choice of investment vehicle, as will new carried interest rules, new NOL limitations, limitations on interest expense, and depreciation changes in the tax reform law.

Listen as our panel of experienced tax professionals discusses the impact of the new tax law on foreign investors buying, holding, and disposing of U.S. real estate.