Changing Investment Structures for Foreign-Owned US Real Property has Many Traps for the Unwary
There are various ways to structure a foreign investment in US real property and each has its own advantages and disadvantages (see below for a link to a previous blog post on this topic). A frequently chosen structure is a pass-through or fiscally transparent structure which, very generally, has income tax advantages (especially upon a disposition of the property), but US estate tax disadvantages. Over time, however, clients age and their plans change, and so we are sometimes called upon to convert a pass-through structure to a structure with US estate tax advantages (i.e., typically by inserting a foreign corporation into the structure), but which has income tax disadvantages. Converting such structures can at first blush seem relatively simple, but there are several traps for the unwary. A common approach to converting such structures is for the foreign client to contribute their ownership interests in the US pass-through entity (such as a partnership or LLC taxed as a partnership or disregarded for federal income tax purposes) to a foreign corporation. Normally, such a transaction would be tax-free under IRC section 351 as a contribution to the capital of a corporation. However, FIRPTA complicates the picture. Specifically, FIRPTA rules add additional requirements in order for this transaction to be tax-free, including that the ownership interest in the US pass-through entity (which is considered a US real estate property interest (“USRPI”) for FIRPTA purposes), be exchanged for another USRPI. Stock of a foreign corporation is generally not a USRPI, and therefore the contribution of the ownership interests in the pass-through entity to the foreign corporation would be considered a taxable sale. There are at least two planning techniques to avoid this issue that involve the use of a US corporation or having the foreign corporation elect to be treated as a US corporation for federal income tax purposes, but both techniques have their own set of advantages and disadvantages that must be carefully considered.
A previous blog post on structuring options for foreign investment in US real estate can be found here:
blog.williamsparker.com/businessandtax/2014/04/15/tax-planning-foreign-investors-purchasing-real-estate