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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(c)(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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