Practical Tax Considerations for Real Estate Investment Trusts (REITs) and Their Foreign Shareholders

Author(s): Rufus Rhoad­es and Alex­ey Man­a­suev Date: Decem­ber 2011

The Back­ground.

This Emerg­ing Issues Analy­sis (EIA) reviews cer­tain tax con­sid­er­a­tions that REITs with for­eign share­hold­ers and those for­eign share­hold­ers need to keep in mind from an oper­a­tional and invest­ment stand­point.

Real Estate Invest­ment Trusts are com­pli­cat­ed struc­tures with spe­cif­ic require­ments, both orga­ni­za­tion­al­ly and oper­a­tional­ly. A dis­cus­sion of those rules is beyond the pur­pose of this EIA. We are only look­ing at how the REIT should treat its for­eign share­hold­ers with spe­cif­ic ref­er­ence to the For­eign Invest­ment in Real Prop­er­ty Tax Act (FIRPTA) rules. [26 USC § 897.]

Ini­tial­ly, for FIRPTA pur­pos­es, a REIT is now called a “qual­i­fied invest­ment enti­ty.” [26 USC § 97(h)(4)(A)(i).] The changed des­ig­na­tion did not alter the rules that apply to for­eign share­hold­ers, so we will con­tin­ue to use the REIT des­ig­na­tion to avoid con­fu­sion.

A REIT is allowed to invest in both U.S. real estate and debt instru­ments secured by real prop­er­ty. [26 USC § 856©(5)(B).] The REIT may earn income clas­si­fied as div­i­dends, inter­est, rents, and gain from the dis­po­si­tion of assets. That income, in the hands of the REIT (as, of course, with all of its oth­er share­hold­ers), will be clas­si­fied as either ordi­nary income or cap­i­tal gain income. Our focus in this EIA is on how the REIT should treat dis­tri­b­u­tions to its for­eign share­hold­ers of both of those kinds of income.

A REIT may or may not be treat­ed as a U.S. real prop­er­ty hold­ing cor­po­ra­tion (“USRPHC”). That des­ig­na­tion turns on the amount of U.S. real estate that the REIT owns. A REIT that does not own the required per­cent­age of U.S. real estate will not be a USRPHC. A debt denom­i­nat­ed REIT will very like­ly not be a USRPHC, for exam­ple.

Dis­tri­b­u­tions of Ordi­nary Income.

1. In Gen­er­al. Since a REIT is an enti­ty that would be tax­able as a domes­tic cor­po­ra­tion if it were not a REIT [26 USC § 856(a)(3)], then its dis­tri­b­u­tions of oper­at­ing income are treat­ed as a div­i­dend. A div­i­dend paid by a domes­tic cor­po­ra­tion is U.S. source income and, when paid to a for­eign per­son, is sub­ject to a 30 per­cent tax with­hold­ing rate unless an exemp­tion under U.S. domes­tic tax law or a U.S. income tax treaty applies. A for­eign share­hold­er who is enti­tled to a reduced treaty rate should give the REIT a Form W‑8 BEN, Cer­tifi­cate of For­eign Sta­tus of Ben­e­fi­cial Own­er for Unit­ed States Tax With­hold­ing. The REIT may rely on that form (unless, of course, the REIT knows that it is incor­rect) and reduce the amount of the with­hold­ing as indi­cat­ed in the form. Most U.S. income tax treaties reduce the amount of with­hold­ing on treaties, 15 per­cent being the most com­mon tax with­hold­ing rate. [See Rhoad­es & Langer, U.S. Inter­na­tion­al Tax­a­tion and Tax Treaties, §50.03[3], which lists the tax treaty with­hold­ing rates for all treaties.]

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