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Proposed Amendment to FIRPTA Could Make U.S. REITs More Attractive to Canadian Real Estate Investors

Proposed Amendment to FIRPTA Could Make U.S. REITs ore Attractive to Canadian Real Estate Investors Legislation is pending in Congress that would reduce the US tax burden imposed on non-US shareholders in some real estate investment trusts (REITs). This article explores how REITs can be used by Canadian investors to structure real estate investments in the United States and examines how the proposal would affect such investors. US real estate investment trusts (REITs) are an increasingly popular vehicle for investments in real estate in the United States and in mortgages secured by such real estate. The reason is that although REITs are treated as corporations for US tax purposes, they are entitled to claim a deduction for dividends paid to their shareholders and as a result can largely avoid US federal corporate-level income tax. While REITs have historically been marketed primarily to domestic investors, there is a growing awareness among tax practitioners of the utility of REITs as vehicles for US real estate investments by non-US persons. A bill was introduced during the first session of the current Congress that is intended to make portfolio investments in publicly traded REITs more attractive to non-US investors. This article will explore the US tax treatment of Canadian investors in a REIT and consider the significance of the proposed legislation. General Requirements for Taxation as a REIT In order for an entity to qualify as a REIT, it must elect to be so treated and must satisfy certain organizational requirements, distribution requirements, income tests, and asset tests. The organizational requirements are as follows: (1) the REIT must be taxable as a domestic corporation; (2) the REIT must be managed by one or more trustees or directors; (3) the shares of the REIT must be freely transferable; (4) the REIT must have at least 100 shareholders; and (5) five or fewer individuals cannot own, directly or indirectly, more than 50 percent of the value of the shares of the REIT (“ the five-or-fewer test” ), taking into account for this purpose certain constructive ownership rules under which a shareholder may be treated as owning shares that are actually owned by certain related persons. There is no requirement that a REIT be publicly traded. A REIT is required to distribute each year at least 90 percent of its taxable income, determined for this purpose by excluding any net capital gain (that is, the excess of net long-term capital gains over short-term capital losses) and certain non-cash income. If the REIT’s shareholders consent, however, the REIT and its shareholders can jointly elect to be treated for all US federal income tax purposes as if the REIT had made a distribution to its shareholders (“ a consent dividend” ), who will be subject to tax on the deemed distribution. The REIT may also elect to treat certain dividends paid after the close of the year as having been paid during the year. This election permits the “ throwback dividends” to be used to satisfy the distribution requirements for the taxable year even though the dividends are includible in the income of the REIT’s shareholders only in the following year. A REIT is required to meet two annual income tests. The first test requires that at least 95 percent of the REIT’s gross income be derived from the following items: “ rents from real property,” as defined below; dividends; interest; gain from the disposition of real property interests (other than dealer property), stocks, or securities; abatements and refunds of taxes on real property; income and gain derived from certain property acquired by foreclosure; and loan or lease commitment fees. The second test requires that at least 75 percent of the REIT’s gross income be derived from items that qualify under the 95 percent test, other than non-mortgage interest, non-REIT dividends, and gains from the sale of stock or securities other than REIT shares. The term “ rents from real property” includes rents from interests in real property and charges for services customarily furnished in connection with the rental of such property, and also includes rent attributable to personal property leased under, or in connection with, a lease of real property if the rent attributable to the personal property does not exceed 15 percent of the total rent. “ Rents from real property” do not include any rental income where (1) any portion of the rent paid by a tenant is dependent on the profits of the tenant, (2) the tenant is 10 percent owned by the REIT (taking into account ownership by certain related persons), or (3) the REIT is providing non-customary services to tenants of the property. The asset tests require that (1) at least 75 percent of the value of the REIT’s assets be comprised of real estate assets, cash and cash items (including receivables), and government securities; (2) not more than 20 percent of the REIT’s assets be represented by securities in one or more taxable REIT subsidiaries (that is, non-REIT corporate subsidiaries that have elected to be taxed as separate entities from the REIT); (3) not more than 5 percent of the REIT’s assets be represented by securities of any one issuer (other than a taxable REIT subsidiary); and (4) the REIT not own more than 10 percent of the vote or value of any issuer (other than a taxable REIT subsidiary). The term “ real estate assets” is defined to include interests in real property including leases (but not mineral, oil, or gas royalty interests), mortgages on real property, and shares in other REITs. Private REITs As mentioned above, there is no requirement that a REIT be publicly traded. However, structuring a private REIT requires careful attention to be paid to the ownership limitations. The beneficial ownership of the REIT’s shares must be sufficiently dispersed among enough individuals in order not to run afoul of the five-or-fewer organizational test. This test is applied by looking through any entities that are shareholders of the REIT to the ultimate individual owners. Thus, the test would not be violated by having a partnership or corporation own more than 50 percent of the REIT’s shares, as long as the ownership of such partnership or corporation is not overly concentrated. However, legislation has been proposed several times that would prohibit a single entity from owning 50 percent or more of the stock of a REIT, and in fact there are several bills pending in Congress that include such a provision. Another hurdle that has to be overcome in structuring a private REIT is the requirement that there be at least 100 shareholders. In contrast to the five-or-fewer test, there is no specified minimum amount of shares that must be held by the 100 shareholders. In addition, the 100 shareholder test may be satisfied not only by common stock holders but also by preferred stock shareholders. Many private REITs are structured with a separate class of non-voting preferred stock that is issued to a sufficient number of unrelated shareholders to ensure that this requirement is satisfied. REIT Taxation While a REIT is only required to distribute 90 percent of its “ ordinary” taxable income in order to maintain its qualification as a REIT, a REIT that fails to distribute all of its taxable income, including capital gains, will be subject to corporate-level tax on the undistributed income just as if it were an ordinary corporation. In addition, the REIT may be subject to a 4 percent excise tax on undistributed amounts. Treatment of Shareholders Distributions made by a REIT to its shareholders are treated as dividends to the extent of any current or accumulated earnings and profits of the REIT. Except in the case of “ capital gain dividends,” such dividends are includible in the gross income of domestic shareholders as ordinary income and generally do not qualify for the 15 percent rate applicable to other dividends paid by US corporations unless the dividends are attributable to qualifying dividend income earned by the REIT. Consent dividends are treated in the same manner as actual distributions. Distributions that exceed the REIT’s earnings and profits are treated as a non-taxable return of the shareholder’s investment to the extent of the shareholder’s basis in the shares. Distributions in excess of the shareholder’s basis are treated in the same manner as gain from a disposition of the shares. To the extent that a REIT has a net capital gain for the taxable year, the REIT may designate dividends that it pays during the year as capital gain dividends. Such dividends are treated as capital gains and are eligible for beneficial long-term capital gains rates in the hands of the REIT’s individual shareholders, without regard to the holding period of the REIT shares in the hands of the shareholders. Such dividends nonetheless reduce the REIT’s taxable income. In addition, if the REIT does not distribute its capital gains to its shareholders, and consequently must pay tax on those amounts, double taxation may be avoided by the REIT’s designating the gains as includible in its shareholders’ income (as if the amounts had actually been distributed). This designation, which does not require the consent of the shareholders, permits the shareholders to claim a credit for the tax actually paid by the REIT on the net capital gain. In the case of individual shareholders, who are entitled to a beneficial long-term capital gain rate, the credit will exceed the tax due on the deemed capital gain dividend and may offset any tax liability for the shareholders’ other income or allow the shareholders to obtain a refund. REIT shares are ordinarily treated as a capital asset in the hands of its shareholders. A sale of the shares will result in long-term capital gain or loss if the shares are held for more than one year. Treatment of Non-US Shareholders Ordinary Dividends Ordinary dividends (that is, dividends other than capital gain dividends) received by a non-US shareholder of a REIT are subject to US withholding tax at a 30 percent rate, subject to reduction under any applicable income tax treaty. Many US treaties, however, limit the availability of relief from US withholding tax on dividends paid by REITs. In particular, the US-Canada income tax treaty does not permit dividends paid by a REIT to qualify for the 5 percent rate otherwise applicable to 10 percent or more corporate shareholders. Further, the 15 percent rate applies only to dividends received by individuals who own less than 10 percent of the REIT’s shares, and all other recipients are subject to 30 percent US withholding tax. Gain on Disposition Gain recognized by a non-US shareholder from the sale of stock in a US corporation is generally not taxable in the United States. However, under the Foreign Investment in Real Property Tax Act of 1980 (“ FIRPTA” ), gain recognized by a non-US person from a disposition of a US real property interest is treated as effectively connected to a US trade or business and is subject to US federal income taxation. Further, a shareholder who recognizes such income is required to file a US federal income tax return. A US real property interest includes stock in a US corporation that is, or was at any time during the preceding five years, a “ United States real property holding corporation” (USRPHC). A USRPHC is any US corporation the fair market value of the US real property interests of which equals or exceeds 50 percent of the total fair market value of the corporation’s US and non-US real property interests plus any of its other assets used in a trade or business. Since the REIT asset tests require that 75 percent of a REIT’s assets consist of real estate assets (or cash, cash equivalents, or government securities), most REITs are USRPHCs under this definition. However, unlike the REIT asset test, the 50 percent test applicable in determining USRPHC status allows the gross value of the corporation’s real estate to be reduced by any mortgage debt in connection with the property. Thus, it is possible for a REIT to meet the 75 percent test, while still avoiding USRPHC status. Even if a REIT is a USRPHC, there are two important exceptions that can protect a non-US investor in the REIT from being subject to US federal income tax on a disposition of the REIT’s shares. Under one exception, if any class of stock of a corporation is regularly traded on an established securities market, stock of such class that is held by a person who, at no time during the five-year period preceding the date of sale, owned more than 5 percent of such class is not treated as a US real property interest. Under the second exception, stock of a REIT is not treated as a US real property interest if the REIT is a “ domestically controlled REIT.” A REIT is treated as a domestically controlled REIT with respect to a sale if, at all times during the five-year period preceding the date of the sale, less than 50 percent in value of the stock was held directly or indirectly by foreign persons. This exception applies to both public and privately held REITs. Capital Gain Dividends Under Code section 897(h)(1), any distribution by a REIT to a non-US shareholder that is attributable to gain from sales or exchanges by the REIT of US real property interests is treated as if it were gain recognized directly by the shareholder from a disposition of such property. Such gain is treated as income effectively connected to a US trade or business subject to US federal income tax, and a distributee non-US shareholder is required to file a US federal income tax return. In the case of a foreign corporation, such gain could also be subject to a 30 percent US branch profits tax. The tax is enforced through a requirement imposed on the REIT to withhold 35 percent of the capital gain distribution. Note that capital gain distributions attributable to US real property gains are taxable even if the REIT is not a USRPHC or if the shareholder who receives the distributions would qualify under one of the two exceptions to FIRPTA described above. Thus, the tax consequences of a capital gain distribution may be more onerous than an actual sale of the REIT shares. However, the shareholder may be able to avoid being subject to section 897(h)(1) by disposing of the REIT shares prior to the distribution. Section 897(h)(1) on its face appears to apply to any dividends attributable to dispositions of US real property interests, whether or not the dividends are designated by the REIT as capital gain dividends, but no regulations have been issued by Treasury under section 897(h)(1). Regulations have been issued under the related provisions of Code section 1445(e)(1), which contain the withholding requirements on capital gain distributions to non-US shareholders, but they shed little light on the operation of section 897(h)(1). For withholding tax purposes, the regulations require the REIT to withhold on the maximum amount of dividends that could have been designated as capital gain dividends. Comparison with Other Forms of Investment in US Real Estate As discussed above, gain recognized by a non-US taxpayer from a sale of REIT shares will be exempt from US taxation in the following three situations: (1) where the value of the REIT’s US real property interests, as defined for FIRPTA purposes, is less than 50 percent of the total value of the REIT’s real property interests and trade or business assets; (2) where the shareholder holds 5 percent or less of a class of the REIT’s shares that is publicly traded; or (3) where the REIT is a domestically controlled REIT. For Canadians interested in investing in US real estate, an investment in such “ exempt REIT shares” offers significant advantages over a direct investment in US real estate. Direct Investment Gain on Sale The principal benefit of structuring an investment in US real estate through exempt REIT shares derives from the treatment of gain on the sale of the investment. Gain on the sale of a direct interest in real estate would be fully taxable under FIRPTA. In contrast, gain on the sale of the exempt REIT shares is not subject to US federal income taxation. While a sale of the underlying real estate may give a rise to a distribution that would be taxable in the hands of the Canadian shareholders, it is often possible to arrange for a sale of the stock prior to the distribution of any sale proceeds. Alternatively, the shareholder could sell the shares of the REIT instead of selling the underlying real estate. A US purchaser of the REIT stock (other than a corporation that becomes an 80 percent shareholder of the REIT) could simply liquidate the REIT immediately and obtain a fair market value basis in the real estate without paying any tax. A direct investor in real estate can generally obtain proceeds from a refinancing of the property without paying any current tax, even if the proceeds exceed the investor’s basis in the property. Similarly, if the REIT refinances its real property, the proceeds can be distributed tax-free to the extent that they exceed the REIT’s earnings and profits, provided that the investor’s shares qualify as exempt REIT shares. Operating Income While net rental income from directly held US real estate would generally be subject to federal income taxation in the hands of a Canadian individual or corporate shareholder at ordinary maximum rates of up to 35 percent, operating income of a REIT will escape US taxation at the corporate level as long as the earnings are distributed to the REIT’s shareholders. Although ordinary dividends may be subject to US withholding tax, the withholding rate for Canadian individual investors who own less than 10 percent of the REIT is reduced from 30 percent to 15 percent, which should be fully creditable in Canada. Canadian corporate shareholders would suffer withholding tax at a 30 percent rate, but that is more favorable than the 35 percent US corporate tax rate that would otherwise apply to the net rental income, and the interposition of a REIT also enables the corporation to avoid the 5 percent branch profits tax that would otherwise apply under the US-Canada income tax treaty. Another important advantage of investing through a REIT is that, unlike a direct investor in US real estate, an investor who receives ordinary (as opposed to capital gain) dividends from a REIT will not be required to file a US federal income tax return as long as withholding taxes were properly withheld at source by the payer. Like income derived from a direct investment in US real estate, the taxable income of a REIT is reduced by depreciation deductions and interest deductions on mortgages and other debt of the REIT. Thus, the US tax savings customarily realized by foreign investors in US real estate from such deductions may still be achieved by funding the REIT through a combination of debt and equity. For tax-exempt investors, such as pension funds and charities, the U.S.-Canada income tax treaty should exempt the dividends from US withholding tax, provided that the REIT is not a related person with respect to the tax-exempt entity. In contrast, income derived directly by a Canadian pension fund exempt investor from a US real estate operation would be subject to US taxation under the US-Canada income tax treaty. Such income would also be taxable to a Canadian charitable organization if the real estate operation constituted a trade or business. Comparison with Investment Through a C Corporation Foreign corporate investors often choose to make investments in US real estate through a US C corporation (that is, an ordinary non-REIT corporation). Assuming that the US corporation is a USRPHC, any gain on the sale of the stock by the Canadian shareholder (or gain resulting from a distribution of proceeds of a refinancing that exceeds the corporation’s earnings and profits) will be subject to US taxation under FIRPTA. The only way to avoid this shareholder-level tax is for the US corporation to first dispose of the real estate in a fully taxable transaction. In contrast, in the case of exempt REIT shares, the shares can be disposed of free of US taxation even if the REIT still owns the real estate. Gain on a sale of the real estate by the C corporation is subject to US taxation in the hands of the corporation at a 35 percent rate. Gain on the sale of real estate by a REIT will be subject to US tax in the hands of the shareholder upon distribution of the sale proceeds. However, such taxation can be avoided by the shareholder’s selling the REIT shares prior to such distribution. A C corporation that owns real estate pays US tax at a maximum marginal rate of 35 percent on its net rental income. Dividend distributions to Canadian corporate shareholders of the C corporation are subject to an additional US withholding tax, which under the US-Canada income tax treat is reduced to 5 percent for corporate shareholders that own at least 10 percent of the US corporation’s stock (resulting in a combined corporate and shareholder tax rate of 38.25 percent) and to 15 percent for other qualifying shareholders. An investment made through a REIT eliminates the US corporate-level tax on net rental income, and while the 30 percent withholding rate on REIT dividends is higher than the withholding rate on ordinary subsidiary dividends, that rate still compares favorably with the combined corporate and shareholder rate of 38.25 percent for rental income of a C corporation distributed to a Canadian corporate shareholder. Investments in REITs by Canadian Real Estate Investment Trusts A great deal has been written in the press recently regarding the use of Canadian income trusts (a form of mutual fund) as a vehicle to pool significant amounts of capital from Canadian individual investors to make acquisitions in the United States. The US investments are typically held through a US holding company, which is subject to US corporate-level tax. Various creative debt-financing structures are used to reduce US federal income and withholding taxes. The Canadian mutual fund trusts are entitled to claim a deduction for distributions for Canadian income tax purposes. Thus, these structures seek to allow the individual investors to receive the income from the underlying US investments with little or no entity-level taxation in the United States or Canada. At least one Canadian real estate investment trust has been formed to acquire a portfolio of US real property, but the authors are not aware of Canadian real estate investment trusts or other mutual fund trusts that have acquired material interests in REITs. A Canadian trust may be characterized for US tax purposes either as a business entity, which could be either a corporation or a partnership, or as a fixed investment trust. If the Canadian trust is a fixed investment trust, the owners of the trust will be treated as owning directly their proportionate shares of the trust’s assets and earning directly any dividends or gains derived from those assets. A discussion of the rules applicable in determining the US tax characterization of an entity formed under foreign law is beyond the scope of this article. However, it should be noted that a Canadian trust can be structured to fit within any of these three classes of entities. A Canadian real estate investment trust or other mutual fund (“ a Canadian trust” ) may find an investment in exempt REIT shares very appealing. However, one significant issue is the imposition of US withholding taxes on dividends paid by the REIT. Whether or not the Canadian trust’s unitholders are individuals, because the trust is the owner of the REIT shares the dividends will not be eligible for any treaty benefits and will be subject to the full 30 percent rate of US withholding tax. The trust itself is not eligible for the 15 percent rate, since that rate is available only to individuals. Regardless of how the Canadian trust is structured to qualify for US tax purposes, the unitholders should be eligible for a foreign tax credit in Canada, although this will not be helpful to tax-exempt unitholders. Some practitioners have argued that if a Canadian trust is structured to qualify for US tax purposes as an investment trust, the United States is required to afford treaty benefits to individual unitholders of the trust. However, this argument fails because under the section 894 regulations an owner of a Canadian entity (even if the entity is disregarded under US law) is treated for treaty purposes as deriving an item of income earned by the entity only if the owner is treated as having earned the income under the laws of Canada. Since mutual fund trusts are not fiscally transparent for Canadian tax purposes, it is the trust rather than the unitholders that will be treated as deriving the dividends under these regulations. Note that if an investment in a REIT were structured through a Canadian publicly traded limited partnership, then, assuming that the entity were also structured to qualify as a partnership for US tax purposes, dividends allocable to individual limited partners who indirectly own less than 10 percent of the REIT would arguably qualify for the 15 percent rate under the US-Canada income tax treaty. In contrast to the Canadian trust situation, here the Code section 894 regulations would treat the limited partners as the ones deriving the income for treaty purposes because the partnership is fiscally transparent for Canadian purposes. Similarly, dividends allocable to a limited partner that is a Canadian tax-exempt entity, such as a qualified pension plan, would arguably qualify for an exemption from US withholding tax under the US-Canada income tax treaty. Interest Income It is common for Canadian trusts investing in the United States to invest a portion of the required capital of the US business in the form of debt. The treatment of interest paid by a REIT to a Canadian trust should be the same as the treatment of interest paid to such an entity by any US C corporation. Assuming that the debt qualifies as indebtedness for US tax purposes (under general debt-equity characterization principles), interest paid to a Canadian trust that is treated as a corporation for US tax purposes will qualify for the portfolio interest exemption from US withholding tax if the Canadian trust owns less than 10 percent of the REIT’s voting power. However, if the Canadian trust qualifies as a fixed investment trust (or, arguably, as a partnership), the 10 percent voting power test should be applied at the unitholder level rather than the trust level. Gain on Disposition For a Canadian trust investing in a US real estate venture, FIRPTA may be avoided by structuring the investment through a domestically controlled REIT; the Canadian trust may acquire up to a 49 percent interest in the REIT, provided that the balance of the REIT’s shares are owned by US persons. Alternatively, in the case of publicly traded REITs, FIRPTA may be avoided with respect to unitholders who, through the trust, own no more than 5 percent of the REIT if the Canadian trust qualifies as a fixed investment trust for US tax purposes (or, arguably, as a partnership). In such cases, the 5 percent test should be applied at the unitholder level. Thus, the trust itself could acquire a 100 percent interest in a publicly traded REIT and still avoid FIRPTA on a sale of the REIT shares if ownership of the trust were sufficiently dispersed. For greater than 5 percent shareholders, however, not only would a sale of the REIT shares by the trust be taxable in the United States, but any sale of units in the Canadian trust would be treated as a taxable sale of the underlying shares in the REIT. If the unitholder were an individual, any gain subject to FIRPTA would be eligible for 15 percent long-term capital gain rates if the unitholder held the indirect interest in the REIT for more than one year. In the event that the REIT planned to dispose of its US real property interests, the trust could avoid taxation of a distribution under Code section 897(h)(1) by selling its shares in the REIT before the dividend was declared. US Return Filing Requirements Non-US taxpayers that earn any income that is treated under FIRPTA as effectively connected to a US trade or business are required to file US federal income tax returns. If a Canadian trust that is treated as a corporation for US federal tax purposes invests in a REIT, whether or not the REIT shares are exempt REIT shares, the unitholders will not be treated as earning any US effectively connected income as a result of their investment in the trust and will not be required to file US income tax returns. However, if the Canadian trust is a fixed investment trust or a partnership for US tax purposes, the unitholders will be treated as receiving their proportionate share of any dividends or gains realized by the Canadian trust, and any FIRTPA gains earned by the trust will trigger a US return filing requirement for the unitholders. Further, any gain recognized by a unitholder on a sale of trust units will be subject to FIRPTA, unless the REIT shares held by the trust are exempt REIT shares. As discussed earlier, the trust may structure and manage its investments in REITs so as not to be subject to FIRPTA (by owning exempt REIT shares and avoiding taxable capital gain dividends). If the trust does not wish to be so limited, the Canadian trust should be structured so that it qualifies as a corporation for US tax purposes. However, this characterization will prevent any capital gain earned by the trust from qualifying for favorable individual long-term capital gain rates. Canadian Tax Issues A Canadian trust investing in a REIT also has to consider the Canadian tax aspects of such an investment. One point to note is that dividends from non-Canadian issuers are ineligible for the gross-up and dividend tax credit rules that apply to dividends paid by Canadian issuers. However, this limitation is not a real disadvantage in the case of an investment in a REIT, since REITs ordinarily distribute all of their taxable income and do not pay any corporate-level tax. A Canadian trust making an investment in a REIT also must consider the potential application of the Canadian foreign investment entity (FIE) rules. The FIE rules are unlikely to apply to an investment in a REIT either because the REIT’s rental activities potentially qualify as an “ exempt business” (if the REIT’s properties are actively managed) or because the shares represent an “ exempt interest.” The latter exclusion is an exception for entities that distribute all of their income currently and are publicly traded. Note that an investment in a REIT would be treated as “ foreign property” under Canada’s Income Tax Act (Canada), RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “ the Act” ). Proposed Legislation As discussed above, Code section 897(h)(1) imposes a US tax on dividends paid by a REIT that are attributable to gains from the disposition of US real property interests. Section 897(h)(1) applies to a non-US shareholder holding shares of a REIT even if the shares are exempt REIT shares. The Real Estate Investment Trust Improvement Act of 2003, identical versions of which are pending in both the Senate and the House of Representatives, would amend section 897(h)(1) to provide that any distribution made by a REIT with respect to any class of stock that is regularly traded on an established securities market will not be treated as gain recognized from the sale or exchange of a US real property interest to the extent that the dividend is paid to a shareholder who does not own more than 5 percent of such class of shares. A similar provision appears in the Jumpstart Our Business Strength (JOBS) Act, which was passed by the Senate on May 11, 2004. In a speech introducing the Senate version of this bill, Senator Orrin G. Hatch described the amendment as follows: Title II of the bill would modify [FIRPTA] to remove barriers to foreign investment in REITs. Today, there is very little foreign investment in REITs. We understand that U.S. money managers routinely receive assignments to place foreign investment capital in the United States under which they have complete discretion to invest in any U.S. stocks except REITs. The reason they are expressly told to avoid REITs is that under FIRPTA, foreign investors that receive capital gains distributions are treated as doing business in the United States. Title II would modify the FIRPTA rules so that a publicly traded REIT’s payment of capital gains dividends to a foreign portfolio investor would no longer cause the REIT investor to be considered doing business in the United States. The effect of this would be to treat investments in REITs like investment in other corporations, and the provision would parallel current law governing a portfolio investor’s sale of REIT stock. The amendment would in fact bring the treatment of investments by 5 percent or less non-US investors in publicly traded REITs into conformity with the treatment that would apply to an investment in a US corporation that is not a USRPHC. In both cases, the only US federal income tax that the investors need be concerned with is the withholding tax on dividends. The proposed amendment would make it possible for a Canadian trust that qualifies as a fixed investment trust (or, arguably, as a partnership) for US tax purposes to avoid FIRPTA not only on sales of publicly traded REIT shares, but also with respect to capital gain dividends, as long as no individual unitholder indirectly owned more than 5 percent of the REIT. The proposed amendment would not, however, treat all capital gain distributions by a REIT with respect to exempt REIT shares in the same manner as gain on the sale of the shares. A capital gain distribution with respect to stock of a non-public REIT would continue to be subject to US income tax on distributions attributable to capital gains of the REIT under section 897(h)(1), whether or not the gain earned by the shareholder directly from a disposition of the shareholder’s shares would be taxable. Thus, section 897(h)(1) would still apply to privately held REIT’s that are not USRPHCs or that rely on the domestically controlled exception to avoid FIRPTA. Conclusion A REIT can be a very tax-efficient vehicle for foreign investors seeking to acquire interests in US real estate. Institutional and other large investors may acquire significant stakes in US real estate by entering into a joint venture structured as a domestically controlled REIT. Sales of their interests in the REIT will not be subject to FIRPTA, and US taxation of distributions of capital gain proceeds under Code section 897(h)(1) can also be avoided by carefully managing the timing of distributions and sales of the REIT’s assets. For individuals and other retail investors who own a 5 percent or less interest in a publicly traded REIT, gain on the sale of shares by shareholders will be tax-free. Avoiding capital gain distributions is likely to be more difficult, but individuals can benefit from reduced long-term capital gain rates that may be available for income from such distributions. Canadian real estate investment trusts may be a good vehicle to bring the benefits of publicly traded and domestically controlled REITs to Canadian retail investors. Because such trusts can pool significant amounts of capital under the management of professional advisors, they may have better access to REIT management. Such access may enable the trust to influence management decisions regarding property sales by the REIT, and provide sufficient notice for the trust to be able to sell the REIT shares prior to distribution of the sale proceeds. However, dividends paid by a REIT to a Canadian trust will be subject to 30 percent US withholding tax. The proposed amendment to FIRPTA would eliminate US taxation of capital gain dividends in the case of a 5 percent or less investment in a publicly traded REIT. The amendment would be particularly helpful for Canadian trusts structured to qualify as fixed investment trusts, since the 5 percent would apply at the unitholder level. The prospects of passage of the proposed amendment are, however, unclear.