TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, October 30, 2012

Herzig: Rethinking FIRPTA

David J. Herzig (Valparaiso), Rethinking FIRPTA, 4 Colum. J. Tax L. ___ (2013):

Since 1980 the United States has taxed U.S. real property gains of foreign investors. A nonresident must pay tax on the capital gain from the sale of U.S. real property or rights in U.S. real property, as well as on the sale of shares in non-publicly held domestic corporations that hold significant U.S. real property assets. The United States imposes a withholding liability on the purchaser based on a percentage of the purchase price. Moreover, by owning U.S. real property, foreign investors are subject to Internal Revenue Service (“IRS”) investigatory powers. Because of these rules foreign investors spend significant resources to structure investment in U.S. real property assets to avoid being deemed an owner of the underlying real property for taxation purposes. This has rendered the underlying statute, The Foreign Investment in Real Property Act of 1980 (“FIRPTA”), elective. This electivity results in the U.S. exhibiting tax haven characteristics for inbound real estate investments. Rather than tightening the rules to eliminate this friction, Congress has recently proposed even less stringent requirements. The resulting narrative by practitioners and policy makers is that FIRPTA should be eliminated. The United States currently needs more, not less, collection of taxation. The fact that FIRPTA is either easily arbitraged or not properly collected should not result in the repeal. This article proposes a new way of addressing FIRPTA by expanding the use of reporting requirements to capture the leakage and provide a mechanism for effectively eliminating the use of structuring to avoid the tax. Through the introduction of systems recently employed in the FATCA regime, Congress can through an effective penalty structure ensure proper collection of taxation and achieve the stated goal of FIRPTA – an equal tax burden independent of the status of the investor. The goal of the proposal is to have a more cohesive and coherent FIRPTA regime by replacing a gross income tax regime with a net income tax regime with a backup withholding. Given the United States’ position as a market leader in a limited market, there should be a more aggressive tax collection stance taken. The U.S. real property market is relatively inelastic as compared to equities; thus, an aggressive United States position will not have much if any downside.

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