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IRS Reduces Built-in Gains Tax Period for REITs to Five Years

New law ahead road signBy:  Amanda Wilson

One of the key benefits of a real estate investment trust (“REIT”) is that it is effectively a pass through entity for income tax purposes.  While a REIT pays tax on its taxable income, it also receives a dividends paid deduction on dividend distributions to its shareholders.  Since a REIT has to distribute at least 90% of its taxable income ever year, this dividends paid deduction effectively wipes out the REIT’s taxable income, avoiding an entity level tax.

To avoid corporations electing REIT status and then selling their assets under this preferential tax regime, the REIT rules require a REIT to pay a built-in gains tax on any gains that were built-in at the time of the REIT election if the REIT disposes of that property within a specified recognition period.  The built-in gains tax rules for REITs are found in Treasury Regulation Section 1.337(d)-7, which applies the S corporation built-in gains tax rules of Section 1374.

The Protecting Americans Against Tax Hikes Act of 2015 (“PATH Act”) amended Section 1374 to reduce the built-in gain recognition period for S corporations from 10 years to 5 years.  Practitioners expected the IRS to modify Treasury Regulation Section 1.337(d)-7 similarly.  However, the IRS instead issued proposed and temporary regulations in the summer of 2016 that kept the built-in gains tax recognition period for REITs at 10 years.

I am happy to share that today, the IRS backed away from this position, and issued final regulations providing that the recognition period for REITs is the same period provided for under Section 1374.  As a result, the recognition period for REITs has been officially reduced from 10 years to 5 years.   This change will go into effect February 17, 2017, but taxpayers may affirmatively apply this new recognition period for any transactions that occurred on or after August 8, 2106

New Partnership Audit Regs Final Before Year End?

By:  Amanda Wilson

At a tax conference yesterday, a Treasury official indicated that Treasury is working hard to finalize regulations before the 60-day freeze that occurs before the inauguration of a new president (Treasury will not issue final regulations during this period).  The official was hoping that the regulations dealing with the new partnership audit rules  (which go into effect for tax years beginning in 2018) could be finalized before this  freeze period.  This may be overly optimistic, as the regulations will undoubtedly be the subject of substantial public comments.

FIRPTA Withholding Tax Set to Increase

New law ahead road signBy:  Amanda Wilson

The Foreign Investment in Real Property Tax Act (FIRPTA) subjects foreign sellers to U.S. tax when they sell their interest in real property located in the U.S., including interests in companies that predominately hold real estate.  To accomplish this, the purchasers generally are required to withhold 10% of the gross sales price when the seller is foreign.   Legislation that was passed at the end of last year (the PATH Act) increases this withholding rate from 10% to 15% effective as of February 16, 2016.  If you are purchasing a U.S. real estate interest from a foreign seller, make sure you are aware of this change and adequately withhold.  If you fail to do so, you may find yourself liable for the extra withholding.

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