FOREIGN INVESTORS in the United States are hoping for modest relief from US taxes, perhaps as part of a bill to provide funding for US highway projects.

The highway trust fund runs out of funding at the end of May.

The United States does not usually tax foreigners on capital gains when they exit US investments. The US needs foreign investment to help fund US budget deficits. However, the Foreign Investment in Real Property Tax Act – called FIRPTA – requires that foreigners pay taxes on capital gains from investing in US land, buildings and other “real property.” FIRPTA was enacted in 1980 at the urging of family farmers who were concerned that foreign demand for US farmland was making it difficult for young families to buy their own farms.

Advocates for relaxing FIRPTA are looking for two changes.

The Senate tax-writing committee approved one on February 11.

Any person buying US real property from a foreigner must generally withhold 10% from the gross sales proceeds and remit the amount to the IRS. A partnership or real estate investment trust must generally withhold 35% of cash distributions to foreigners to the extent the distributions are attributable to sales of US real property. The foreigner can ask the IRS for a refund if the amount withheld exceeds the taxes on the actual gain. For example, suppose a foreigner sells a US building for $100X, but at a profit or gain of only $5X. The taxes withheld by the buyer in that case will greatly exceed what the seller actually owes. Smart buyers always ask for proof that the seller is not a foreigner. A buyer who fails to withhold will have to pay the seller’s taxes.

Special rules apply to foreigners who hold interests in US real property through real estate investment trusts, or REITs. If the REIT is domestically controlled, meaning less than 50% of the shares are held by foreigners, then a foreigner can sell his shares in the REIT without being subject to tax under FIRPTA, even if the REIT’s assets are entirely US real estate.

As already noted, when a REIT distributes cash to shareholders, it must normally withhold 35% of distributions to foreign shareholders to the extent a distribution is attributable to a sale of US real property. However, no withholding is required on distributions to foreign shareholders in publicly-traded REITs who own no more than 5% of the REIT shares. FIRPTA does not require that such shareholders pay tax on gains. Therefore, unless the distribution is considered a dividend, it would not be subject to any US tax.

The Senate tax-writing committee voted to increase the 5% to 10%. It also decided that shares in publicly-traded REITs owned by persons who own less than 5% of the shares will be treated as domestically held unless then REIT has actual knowledge that the shares are held by a foreigner.

President Obama called in his budget message to Congress in early February for a second change. He wants to exempt foreign pension funds from FIRPTA taxes on the theory that this would put such pension funds on an equal footing with US pension funds. US pension funds are generally exempted from US taxes. Advocates for the change want to make it easier for foreign pension funds to make badly-needed investments in US infrastructure.

Keith Martin in Washington