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.
This is the Senate Finance Committee’s explanation of the current law, the proposed change, and why it’s needed. Look at Section 230 of S. 1637, for you legislation nuts.
A real estate investment trust (“REIT”) is a U.S. entity that derives most of its income from passive real-estate-related investments. A REIT must satisfy
a number of tests on an annual basis that relate to the entity’s organizational structure, the source of its income, and the nature of its assets. If an
electing entity meets the requirements for REIT status, the portion of its income that is distributed to its investors each year generally is treated as a
dividend deductible by the REIT, and includible in income by its investors. In this manner, the distributed income of the REIT is not taxed at the entity
level. The distributed income is taxed only at the investor level. A REIT generally is required to distribute 90 percent of its income to its investors
before the end of its taxable year.
Special U.S. tax rules apply to gains of foreign persons attributable to dispositions of interests in U.S. real property, including certain transactions
involving REITs. The rules governing the imposition and collection of tax on such dispositions are contained in a series of provisions that were enacted in
1980 and that are collectively referred to as the Foreign Investment in Real Property Tax Act (“FIRPTA”).
In general, FIRPTA provides that gain or loss of a foreign person from the disposition of a U.S. real property interest is taken into account for U.S. tax
purposes as if such gain or loss were effectively connected with a U.S. trade or business during the taxable year. Accordingly, foreign persons generally are
subject to U.S. tax on any gain from a disposition of a U.S. real property interest at the same rates that apply to similar income received by U.S.
persons. For these purposes, the receipt of a distribution from a REIT is treated as a disposition of a U.S. real property interest by the recipient to
the extent that it is attributable to a sale or exchange of a U.S. real property interest by the REIT. These capital gains distributions from REITs generally are
subject to withholding tax at a rate of 35 percent (or a lower treaty rate). In addition, the recipients of these capital gains distributions are required to
file Federal income tax returns in the United States, since the recipients are treated as earning income effectively connected with a U.S. trade or business.
In addition, foreign corporations that have effectively connected income generally are subject to the branch profits tax at a 30-percent rate (or a lower
Reasons for Change
The Committee believes that it is appropriate to provide greater conformity in the tax consequences of REIT distributions and other corporate stock
Explanation of Provision
The provision removes from treatment as effectively connected income for a foreign investor a capital gain distribution from a REIT, provided that (1) the
distribution is received with respect to a class of stock that is regularly traded on an established securities market located in the United States and (2)
the foreign investor does not own more than 5 percent of the class of stock at any time during the taxable year within which the distribution is received.
Thus, a foreign investor is not required to file a U.S. Federal income tax return by reason of receiving such a distribution. The distribution is to be
treated as a REIT dividend to that investor, taxed as a REIT dividend that is not a capital gain. Also, the branch profits tax no longer applies to such a