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The Effect of Tax Reform on Real Estate and Professional Service Firms (Part 2)

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Roger Royse's presentation on the effect of Tax Reform on Real Estate and Professional Service Firms. This is part 2 or 2.

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The Effect of Tax Reform on Real Estate and Professional Service Firms (Part 2)

  1. 1. THE EFFECT OF TAX REFORM ON REAL ESTATE AND PROFESSIONAL SERVICE FIRMS Roger Royse rroyse@rroyselaw.com www.rroyselaw.com Research Assistant: Natalie Ryang The Santa Clara County Bar Part I. Tax Cuts and Job Acts (TCJA) Part II. Foreign Partners in U.S. Partnerships Part III. Foreign Investment in the U.S. Real Estate
  2. 2. No information contained in this presentation is to be construed as legal advice. No information contained in this presentation is intended or related to any particular factual situation. Nothing herein forms an attorney-client relationship. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Part II. Cryptocurrency Regulation 2 Disclaimer
  3. 3. Foreign partners in the U.S. Partnership • Is a foreign partner’s sale proceeds treated as “effectively connected income” taxable under Rev. Rule 91-32? • Effectively Connected Income (ECI) is taxable in the U.S. • If treated as capital gain, generally not taxable in the U.S. • Rev. Rul. 91-32: a foreign partner who sells an interest in a partnership is subject to US taxation if the partnership is engaged in a US trade or business – “ECI” • Many US taxpayers tried to ignore this Revenue Ruling, arguing any gain should be capital gain • Obama Administration, in its proposed budget, recommended codifying Rev. Rul. 91- 32 and adding a withholding obligation. Part I. Tax Cuts and Jobs Acts 3
  4. 4. Grecian Magnesite and New IRC § 864(c)(8): • Grecian Magnesite v. CIR, 149 T.C. (2017): US Tax Court rejected Rev. Rul. 91-32, holding that gain or loss recognized by a foreign partner disposing of a P/S interest is generally not considered ECI • New IRC § 864(c)(8): effectively reverses Grecian Magnesite holding • Enacted as part of the 2017 TCJA • Treats as ECI the foreign partner’s “distributive share of the amount of gain (or loss) which would have been ECI if the partnership entity has sold all of its assets at FMV just prior to the foreign partner’s disposition (but reduced for any gain already subject to the FRPTA regime). Part I. Tax Cuts and Jobs Acts 4
  5. 5. Part I. Tax Cuts and Jobs Acts 5 864(c)(8) Gain or loss of foreign persons from sale or exchange of certain partnership interests (A) In general. Notwithstanding any other provision of this subtitle, if a nonresident alien individual or foreign corporation owns, directly or indirectly, an interest in a partnership which is engaged in any trade or business within the United States, gain or loss on the sale or exchange of all (or any portion of) such interest shall be treated as effectively connected with the conduct of such trade or business to the extent such gain or loss does not exceed the amount determined under subparagraph (B). (B) Amount treated as effectively connected. The amount determined under this subparagraph with respect to any partnership interest sold or exchanged— (i) in the case of any gain on the sale or exchange of the partnership interest, is— (I) the portion of the partner’s distributive share of the amount of gain which would have been effectively connected with the conduct of a trade or business within the United States if the partnership had sold all of its assets at their fair market value as of the date of the sale or exchange of such interest, or (II) zero if no gain on such deemed sale would have been so effectively connected,
  6. 6. Foreign partners in the Partnership Part I. Tax Cuts and Jobs Acts 6 Non-US Partner P/S US Trade/Biz #2 (ECI assets) US Trade/ Biz #1 (no ECI) Partner 3rd Party Buyer Sale of P/S Interest US Group Issue: To what extent, if any, should Foreign Partner’s sale proceeds be treated as ECI (taxable in US) or as capital gain (generally not taxable in US)?
  7. 7. New IRC § 864(c)(8) • Foreign partners will be taxed on sales/exchange of their interests in partnerships that conduct a trade or business in the U.S. • § 864(c)(8)(A) applies to tiered P/S structures: interests in a partnership that holds ECI assets, and is held by a partner indirectly through other partnerships, is subject to new 864(c)(8) Part I. Tax Cuts and Jobs Acts 7
  8. 8. New IRC § 864(c)(8) • Coordination with the FIRPTA rules to avoid double taxation: the amount of gain or loss on the sale, exchange or other disposition of the partnership interest that is treated as ECI under subparagraph (A) shall be reduced by the amount of gain or loss on such disposition that is treated as effectively connected under §897 (i.e., the FIRPTA rules). • The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) authorizes the US to tax foreign persons on dispositions of “U.S. real property interests.” • When a foreign person disposes of a U.S. real property interest in a sale, exchange, or transactions that normally would be a non-recognition transactions, FIRPTA treats such gains as “effectively connected income” (ECI), and imposes withholding obligations under § 1445. 15% withholding rate. Part I. Tax Cuts and Jobs Acts 8
  9. 9. New IRC § 864(c)(8) • § 864(c)(8)(E) grants regulatory authority to Treasury to promulgate Regs or other appropriate guidance for the applying § 864(c)(8), • Example: If a P/S interest is contributed by a non-US partner to a corporation, should the non-recognition rule of §351 be turned off? • Section 864(c)(8) does not purport to override any non-recognition provisions. Part I. Tax Cuts and Jobs Acts 9
  10. 10. New IRC § 864(c)(8) Part I. Tax Cuts and Jobs Acts 10 (C) Coordination with United States real property interests. If a partnership described in subparagraph (A) holds any United States real property interest (as defined in section 897(c)) at the time of the sale or exchange of the partnership interest, then the gain or loss treated as effectively connected income under subparagraph (A) shall be reduced by the amount so treated with respect to such United States real property interest under section 897. (D) Sale or exchange. For purposes of this paragraph, the term “sale or exchange” means any sale, exchange, or other disposition. .
  11. 11. New §1446(f) Transferee Withholding • As part of the 2017 US Tax Act, Congress also enacted a new withholding requirement—IRC section 1446(f). • Section 1446(f) provides that, if the portion of the gain (if any) on a disposition of an interest in a partnership would be treated under § 864(c)(8) as ECI, the transferee of the partnership interest [i.e., Buyer] must withhold tax equal to 10% of the amount realized on the disposition. Part I. Tax Cuts and Jobs Acts 11
  12. 12. • Notice 2018-29 provides guidance with respect to the new withholding provision IRC §1446(f) • Notice directs transferees to apply § 1445 principles and forms for reporting and paying withholding tax until specific guidance and forms are issued under § 1446(f). • Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests • Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. Part I. Tax Cuts and Jobs Acts 12 IRS Notice 2018-29: re new §1446(f)
  13. 13. • Provide guidance on • How to determine liabilities in calculating the “amount realized” • Coordination withholding rules of § 1446(f) with FIRPTA’s withholding regime • Application of withholding in the context of tiered partnerships • Partnership’s backup withholding on distributions to the new transferee partner. • Complete redemptions of a foreign partner’s P/S interest Part I. Tax Cuts and Jobs Acts 13 IRS Notice 2018-29: re new §1446(f)
  14. 14. • Provide LIMITED EXCEPTIONS from duty to withhold: may be temporary • Not a “foreign person” transferor furnishes affidavits signed under penalty of perjury • Zero realized gain: Transferee receives a certification • 1st de minimis rule: Transferee receives a certification that Transferor’s allocable share of ECI was < 25 % of its distributive share of income for each of the three prior taxable years in which Transferor was a partner (for the entire year). • 2nd de minimis rule – ECI would be < 25% of total gain on the deemed sale: Transferee receives a certification . Notice says the < 25% threshold will be reduced in forthcoming Regs. • Non-Recognition Transactions: Transferor is not required to recognized any gain or loss by reason of a non-recognition provision. (E.g., § 351 incorporating transactions.) Part I. Tax Cuts and Jobs Acts 14 IRS Notice 2018-29: re new §1446(f)
  15. 15. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner • Facts: Foreign Co. sells its 30% interest in US P/S to an unrelated party on Feb 14, 2018 • Question: How much of the remaining outside gain is treated as ECI, thus taxable in the U.S.?
  16. 16. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner • Under §864(c)(8), For Co’s realized gain is treated as ECI • Income “effectively connected with the conduct of a US trade/business • Will be reduced by real property gains that would already be separately taxed as ECI under the FIRPTA regime).
  17. 17. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner •Hypothetical sale of all of P/S’s assets •$600 US Real Property gain •$300 ECI gain in personal property assets • Total of $900 ECI gain. • The amount treated as ECI is reduced by the amount that would already be taxed as ECI under the § 896(g) of the FIRPTA regime—here $600. •FIRPTA gain: treated as ECI
  18. 18. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner • Thus, 30% of the inherent $600 FIRPTA gain (i.e., $180) is allowed to first offset •For Co.’s OUTSIDE gain on the sale of its P/S interest--($450 realized gain less $180 = $270.
  19. 19. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner • For Co.’s 30% distributive share of the $900 total ECI gains = $270. •That $270, representing For Co’s share of total ECI gain is also offset by 30% of the FIRPTA gain: ($270 - $180 =$90). •Answer: Under § 864(c), $90 of For. Co.’s realized gain on the sale of its P/S interest is treated as ECI—and taxed in the U.S.
  20. 20. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner • Analysis of transferee withholding duty under §1446(f) and Notice 2018-29: • §1446(f) became effective Jan. 1, 2018, and it applies to this sale of For Co’s P/S interest which occurred on Feb. 14, 2018. • Section 10 of Notice 2018-29 provides that if a transferee is required to withhold on an “amount realized” under §1446(e)(5) or Reg. § 1.1445-11T(d) only FIRPTA withholding applies.
  21. 21. Case Study: Disposition of P/S Interest (with US Trade/Biz) by Foreign Partner • Analysis of transferee withholding duty under §1446(f) and Notice 2018-29: • However, there is no FIRPTA withholding in this example because the P/S assets are not 90% US Real Property Interests and cash. * • Thus, withholding under new 1446(f) conceivably applies to the ENTIRE amount realized—i.e., 10% w/h X $600 = $60. * A partnership interest is a USRPI in its entirety if 50% or more of the value of the gross assets consists of USRPIs and 90% or more of the value of the gross assets consists of USRPIs plus any cash or cash equivalents (50/90 test).
  22. 22. ROYSE LAW FIRM, PC For questions , Contact PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 SANTA MONICA 520 Broadway Suite 200 Santa Monica, CA 90401 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw ORANGE COUNTY 135 S. State College Blvd Suite 200 Brea, CA 92821 Research Assistant: Natalie Ryang nryang@rroyselaw.com 22Part I. Tax Cuts and Jobs Acts

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