GOP and CRE Clash With Treasury Over REIT Tax-Law Proposal

A Treasury policy would undo exemptions foreign REIT investors have typically enjoyed

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Republicans in Congress and commercial real estate are voicing their opposition against the Treasury Department and Treasury Secretary Janet Yellen over a proposed rule change that would impose new taxes on domestic real estate investment trusts (REITs) if they exceed a 25 percent threshold of foreign ownership.

The squabble began earlier this year, but picked up steam in recent days after Republican Congress Members Darin LaHood (R-IL) and Carol Miller (R-WV) authored a July 28 letter to Yellen requesting that her agency withdraw a proposed rule change over how domestic investment tax structure vehicles are taxed. 

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Yellen’s proposed rule would trigger capital gains taxes on domestic REITs under the Foreign Investment in Real Property Tax Act (FIRPTA) of 1980 if more than 25 percent of domestic REIT ownership is held by foreign investors. 

Miller and LaHood argued that retroactively changing an established rule on domestic REITs would go against 43 years of precedent and undo rules that have been in place for 14 years for domestic C corporations — where owners or shareholders are taxed separately from the investment entity, like REITs — possibly impacting commercial real investment across the board. 

“The proposed regulations retroactivity is severely burdensome and is already having a chilling effect on foreign investment,” wrote LaHood and Miller in their July 28 letter. “Unfairly treating those who invested in our communities and helped American businesses flourish for the past several decades sends the message to future investors that U.S. tax law is unreliable and unwelcoming to much-needed foreign capital.” 

The crux of the rule change comes out of a December 28, 2022 proposal from the Internal Revenue Service that sought to amend Section 897 of the tax code. Section 897 treats any gains or losses a foreign investor or foreign corporation receives from U.S. property interest as exempt from capital gains taxes typically levied on foreign governments under FIRPTA. 

Treasury officials argued that qualified investment entities (QIEs) like REITs were never intended to be granted exemptions; they’re typically given to domestic investment vehicles in the event that they are mainly controlled by foreign ownership or qualified foreign pension funds (QFPFs). 

“It is not clear that the intent behind section 897(l) was to provide that a QIE is domestically controlled if it is majority owned by QFPFs, as there was no indication that Congress intended that result,” Treasury officials wrote.  

The unique business model of REITs has made them popular with investors for decades. As landlords or investment entities who lease space and collect rent on their properties, REITs distribute that income as dividends to shareholders. Their tax structure requires them to pay a minimum of 90 percent of taxable income to shareholders as dividends each year. 

Treasury officials also stated that their proposed retroactive rule change would not run afoul with the 2015 Protecting Americans From Tax Hikes (PATH) Act, a bi-partisan law signed by former President Obama which, among other things, established a set of rules for the REIT industry. They argued that their proposed rule change instead clarifies some confusion currently existing in the law that has allowed foreign investment to masquerade as domestic investment in property investment. 

“Ultimately, as a technical correction, the modification to section 897(l) cannot expand on the policy Congress intended to enact in the PATH Act,” the Treasury wrote. “A technical correction is a change that clarifies existing law, such as through correcting errors, rather than one that fundamentally or substantively changes the law.” 

But now the commercial real estate industry and some GOP allies in Congress have mobilized to try and halt the Treasury’s proposal, arguing against it on both procedural grounds and in terms of existing economic theory. 

LaHood and Miller wrote that they had doubts whether the Treasury could “unilaterally rewrite existing tax law,” and noted that Congress declined to initiate new taxes against foreign investment in domestic investment vehicles in the 2015 PATH Act. 

Moreover, 16 national CRE organizations — including The Real Estate Roundtable, NAREIT, Institute of Real Estate Management, National Apartment Association and the American Hotel and Lodging Association — authored a joint letter on March 1 to leaders of the U.S. Senate Committee on Finance and the House Ways and Means Committee. They requested that Congress pressure the Treasury to withdraw their rule change proposal. 

The CRE industry letter argued that the FIRPTA of 1980 exempted taxes on the sales of domestically controlled REITs when less than half of the REITs stock is owned by foreign investors. 

“The [domestically controlled] REIT rules have allowed many U.S. real estate businesses to flourish by continuing to attract foreign investment for projects that boost job growth, increase affordable housing and improve communities,” the letter said.  

Other signatories to the letter included AFIRE, American Resort Development Association, American Seniors Housing Association, BOMA International, CCIM Institute, ICSC, Institute for Portfolio Alternatives, National Association of Realtors, National Multifamily Housing Council and National Rental Home Council.  

The CRE groups fiercely defended the current rules in Congress and said that the Treasury is overstepping its bounds with the new proposal. 

“The Congressional policy is the rational and appropriate policy,” the letter said. “A domestic C corporation shareholder of a REIT is not evading or escaping tax on the (domestically controlled) REIT’s ordinary or capital gain income. The proposed regulations override and supersede this repeatedly affirmed Congressional policy.” 

Neither Rep. LaHood nor Rep. Miller responded to a request for comment. Treasury officials did not return a request for comment, either. 

Brian Pascus can be reached at bpascus@commercialobserver.com.