Right now if you’re a U.S. nonresident and you buy publicly traded REIT shares, you have a U.S. tax monstrosity facing you. At the end of the year the REIT will declare a dividend, comprised of regular income (from rent earned) and capital gain (from sales of real estate owned). Due to a quirk in Section 897, this forces the foreigner to file a U.S. tax return reporting the capital gain and paying tax on it.
Compare that to a nonresident buying a stock in a U.S. company that pays dividends. The nonresident will face the possibility of having a withholding tax imposed on the dividend at 30% (down to zero based on income tax treaties, though). But there is no U.S. tax return required to be filed.
The new law proposes to even the playing field so that investors in publicly traded U.S. stock won’t have this tax wrinkle to contend with when deciding whether to buy REIT stock. Now REIT dividends will be taxed entirely as dividends. The investor doesn’t have to worry about tax returns anymore.
Click on the “Read More” link below if you want to read the Senate Finance Committee’s explanation of the old law and the proposed changes.
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Senator Hatch has introduced a bill in the Senate to tweak the rules for REITS (Real Estate Investment Trusts). This is undoubtedly due in large part to hard work by Tony Edwards at NAREIT.
Most of it does not concern us in the international tax field. But one piece does. Section 201 of the Bill creates a fix to Section 897. This is the part of the Internal Revenue Code that makes sure that foreign investors in U.S. real estate pay capital gains tax on their profits when they sell.
The proposed legislation is intended to eliminate a major conundrum that currently exists for foreign purchasers of REIT stock. Here’s the legislative language.
TITLE II — FIRPTA CORRECTION
SEC. 201. MODIFICATION OF THE TREATMENT OF CERTAIN REIT DISTRIBUTIONS ATTRIBUTABLE TO GAIN FROM SALES OR EXCHANGES OF UNITED STATES REAL PROPERTY INTERESTS.
(a) IN GENERAL. — Paragraph (1) of section 897(h) (relating to look-through of distributions) is amended by inserting before the period at the end the following: ‘, except that any distribution by a REIT with respect to any class of stock which is regularly traded on an established securities market located in the Unites States shall not be treated as gain recognized from the sale or exchange of a United States real property interest if the shareholder did not own more than 5 percent of such class of stock during the taxable year.’.
(b) EFFECTIVE DATE. — The amendment made by this section shall apply to taxable years beginning after the date of the enactment of this Act.
Links: see the remarks in the Congressional Record here. The NAREIT page with information on this legislation is here.
Net result: this means that the capital gain passthrough to a foreign shareholder in a REIT is not within the ambit of Section 897.