Tax Impacts

FIRPTA Reform Needed Now to Ease Commercial Real Estate Equity Gap,

Posted on Thursday, June 30, 2011

FIRPTA Reform Needed Now to Ease Commercial Real Estate Equity Gap, Roundtable Testifies; Obama Issues Statement Encouraging Foreign Investment in U.S.
Testifying before a House Ways and Means subcommittee yesterday, Roundtable President and CEO Jeff DeBoer urged Congress to move quickly in reforming the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), asserting there is “no need, or time, to wait for overall tax reform to act in this area.” He also called for definitive guidance from Treasury regarding tax code Section 864 — the “Effectively Connected Income” (ECI) rules — explaining that uncertainty in this area is inhibiting foreign investment in U.S. commercial real estate debt. (Download - .pdf of Written Testimony or .pdf of Oral Statement)

Although some urban gateway markets “have started to come back,” DeBoer explained that “most commercial real estate markets nationwide remain deeply troubled” by weak property values, lack of business expansion and extremely low consumer confidence. The combination of “steep property value declines and restrictive credit availability” means that “trillions of dollars in commercial real estate debt nationwide will not be able to be refinanced without large infusions of equity capital.”

Potentially higher loan defaults by commercial property owners would only increase burdens on U.S. banks and weaken their ability to lend to small businesses for job creation and expansion — further endangering economic recovery. “The potential for commercial real estate defaults to derail a fragile economic recovery, particularly in non-gateway markets — and to lead to even further job losses, bank closures and business retraction — is very real,” DeBoer warned.

Although the real estate community agrees that increased equity investment would help “bridge the gap between available financing and maturing debt” — and although foreign investors are “ready and willing to invest” in U.S. commercial real estate — the outdated and discriminatory FIRPTA law “makes it highly undesirable” from an economic and administrative standpoint, he testified.

Recognizing that the loss of federal revenue from outright repeal of FIRPTA may be difficult in today’s challenging budget environment, DeBoer urged two “reasonable, cost-efficient” reforms that could be undertaken in the short term:
Raising the existing small shareholder exception for foreign investments in publicly-traded Real Estate Investment Trusts (REIT) from the 5 percent to 10 percent
• Withdrawing IRS Notice 2007-55, which as of 2007 applied FIRPTA to liquidating distributions received by foreign investors from private, domestically-controlled REITs. This step, which does not require legislation, would have significant positive benefits in smaller markets where capital investment is most needed, DeBoer explained.
House Ways and Means Committee member Joe Crowley (D-NY), who is a key sponsor of FIRPTA reform legislation, said during the subcommittee hearing that he and Congressman Kevin Brady (R-TX) are gathering signatures on a letter that will be sent to Treasury shortly requesting administrative withdrawal of the 2007 IRS ruling.

DeBoer also welcomed a June 20 White House statement on the benefits of foreign investment in the U.S.

“President Obama had it absolutely correct earlier this week when he said, ‘[i]nvestments by foreign-domiciled companies and investors create well-paid jobs, contribute to economic growth, boost productivity, and support American communities.’ Unfortunately, the reality is: in the case of foreign investment in U.S. real estate, and in U.S. real estate-related debt, our current laws significantly discourage the type of job-creating economic growth the President was touting,’” DeBoer told the Ways and Means Subcommittee on Select Revenue Measures.

He added that the U.S. commercial real estate market has now “slipped to third in the race for global funds behind the UK and Germany.”

When he announced the hearing recently, Subcommittee Chairman Pat Tiberi (R-OH) said he planned to examine tax concerns that foreign firms share with their U.S. counterparts — “such as the high corporate rate”— along with tax issues that are unique to foreign investors. Like Obama, he cited the economic benefits of foreign direct investment, saying it is “critical to growing the economy and creating jobs.”
Two panels of witnesses testified at yesterday’s hearing. In addition to The Roundtable, other participating organizations included the Organization for International Investment; Nestle Holdings, Inc.; Dassault Falcon Jet Corp; Peterson Institute for International Economics; Deloitte Tax LLP; and the University of Houston Law Center.

FIRPTA and ECI reform were also a key issue at The Roundtable’s 2011 Annual meeting and Tax Policy Advisory Committee (TPAC) Meeting last week. As part of a panel discussion that included Roundtable members, White House economist Brian Deese and New York Fed official Adam Ashcraft, Robert J. Speyer (Tishman Speyer) restated the need for FIRPTA reform — noting that if the legislative environment remains too difficult for passage of such legislation, FIRPTA reforms could be made via administrative action by the U.S. Treasury.

DeBoer, who moderated the panel, told Deese “this is one administrative action” that could be done without legislation and that “would spur a huge amount of inbound capital.” Deese promised to take The Roundtable’s message back to his colleagues at Treasury.

On the ECI issue, as reported in Roundtable Weekly on June 3, The Roundtable has been urging Treasury/IRS to develop definitive guidance on the ECI rules so that non-U.S. investors can increase their participation in U.S. credit markets without risk of adverse U.S. tax consequences. Due to the lack of clarity in this area, transactions that could help expand liquidity and provide long-term benefits to the U.S. economy (e.g., the purchase of loans on the secondary market and, where applicable, restructuring of loans and other securities) are not being undertaken.

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