While taxpayers may be accustomed to law changes bringing bad news, the Protecting Americans From Tax Hikes Act of 2015 (the PATH Act) had some important taxpayer-friendly provisions. With respect to the taxation of foreigners, the PATH Act created and expanded a number of exceptions to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) rules that generally govern the taxation of foreign persons selling interests in real estate located in the United States. One such provision may encourage a significant increase in the investments of foreign pension funds in U.S. real estate through real estate investment trusts (REITs).
Background
In general, foreign persons (i.e., nonresident alien individuals and foreign corporations) can be subject to U.S. tax under two separate schemes. First, a foreign person is subject to U.S. tax on taxable income that is “effectively connected” with a trade or business in the United States (“effectively connected income” or ECI). This tax is generally imposed on net income at the same rates as for a U.S. person (which can include capital gain rates if applicable). Second, if a foreign person receives income that is not ECI, the foreign person is generally subject to tax with respect to certain specific categories of income. These categories include interest, dividends, rents, and royalties from sources within the United States (“fixed or determinable, annual or periodical” income, or FDAP income). FDAP income is generally subject to a 30 percent withholding tax on the gross amounts.
