Section 897 of the Internal Revenue Code provides that gain or loss of a nonresident alien or foreign corporation from the disposition of a United States real property interest is subject to U.S. federal income tax.[1] And, section 1445 of the Internal Revenue Code generally requires withholding of 15 percent of the amount realized on any disposition by a foreign person of a United States real property interest.[2]
But so:
What’s a U.S. Real Property Interest?
For purposes of FIRPTA, a “U.S. real property interest” is defined as an interest in:
- real property located in the states of the United States, the District of Columbia, or the Virgin Islands; or
- a corporation created or organized in the United States or under the law of the United States or of any State, unless it’s shown that the corporation wasn’t a United States real property holding corporation at any time during the 5-year period ending with the date of the disposition of the interest in the corporation.[3]
A “United States real property holding corporation,” in turn, generally means any corporation if the fair market value of its United States real property interests makes up at least 50 percent of the fair market value of the sum of:
- its United States real property interests,
- its interests in real property located outside the United States, and
- any other of its assets which are used or held for use in a trade or business.[4]
So, another question:
What’s an Interest in Real Property?
For purposes of FIRPTA, the Internal Revenue Code defines an “interest in real property” to include “fee ownership and co-ownership of land or improvements thereon, leaseholds of land or improvements thereon, options to acquire land or improvements thereon, and options to acquire leaseholds of land or improvements thereon.”[5]
The Treasury Regulations expand upon the meaning of an “interest” to mean “any interest, other than an interest solely as a creditor . . . .”[6] An interest in real property other than an interest solely as a creditor includes:
- a fee ownership, co-ownership, or leasehold interest in real property;
- a time-sharing interest in real property;
- a life estate, remainder, or reversionary interest in real property;
- an option, contract, or a right of first refusal to acquire an interest in real property other than an interest solely as a creditor;
- a direct or indirect right to share in the appreciation in the value, or in the gross or net proceeds or profits generated by, the real property.[7]
An example of this latter type of real property would be “[a] loan to an individual or entity under the terms of which a holder of the indebtedness has any direct or indirect right to share in the appreciation in value of, or the gross or net proceeds or profits generated by, an interest in real property of the debtor or of a related person is, in its entirety, an interest in real property other than solely as a creditor.”[8]
OK, so now an even more basic question:
What is Real Property?
“Real property” includes land and unsevered natural products of the land, improvements, and personal property associated with the use of real property.[9] Included in these three broad categories are:
- growing crops and timber;[10]
- mines, wells, and other natural deposits;[11]
- buildings, any other inherently permanent structure, or the structural components of either;[12]
- certain personal property used in mining, farming, and forestry;[13]
- certain personal property used in the improvement of real property;[14]
- certain personal property used in the operation of lodging facilities;[15] and
- certain personal property used in the rental of furnished offices and other workspaces.[16]
Personal property that becomes associated with the use of real property generally is treated as a real property interest on its disposition unless:
- the personal property is disposed of more than one year before the disposition of any present right to use or occupy the real property with which it was associated;
- the personal property is disposed of more than one year after the disposition of all present rights to use or occupy the real property with which it was associated; or
- the personal property and the real property with which it was associated are separately sold to persons that are related neither to the transferor nor to one another.[17]
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[1] I.R.C. §§ 871(b)(1), 882(a)(1), 897(a).
[2] I.R.C. § 1445(a).
[3] See I.R.C. §§ 897(c)(1), 7701(a)(4), (9).
[4] I.R.C. § 897(c)(2).
[5] I.R.C. § 897.
[6] Treas. Reg. § 1.897-1(c)(1).
[7] Treas. Reg. § 1.897-1(d)(2)(i).
[8] Id.
[9] Treas. Reg. § 1.897-1(b)(1).
[10] Treas. Reg. § 1.897-1(b)(2). Crops and timber stop being real property when they’re severed from the land. Id.
[11] Treas. Reg. § 1.897-1(b)(2). Ores, minerals, and other natural deposits stop being real property when they’re extracted from the ground. Id.
[12] Treas. Reg. § 1.897-1(b)(2). A “building” means “any structure any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores.” Id. 1.897-1(b)(3)(ii). An “inherently permanent structure” includes any property not mentioned above “that is affixed to real property [including being affixed by weight alone] and that will ordinarily remain affixed for an indefinite period of time.” Id. § 1.897-1(b)(3)(iii)(A). Thus, an “inherently permanent structure” includes “swimming pools, paved parking areas and other pavements, special foundations for heavy equipment, wharves and docks, bridges, fences, inherently permanent advertising displays, inherently permanent outdoor lighting facilities, railroad tracks and signals, telephone poles, permanently installed telephone and television cables, broadcasting towers, oil derricks, oil and gas pipelines, oil and gas storage tanks, grain storage bins, and silos.” Id. § 1.897-1(b)(3)(iii)(B). “Structural components of buildings and other inherently permanent structures” include “walls, partitions, floors, ceilings, windows, doors, wiring, plumbing, central heating and central air conditioning systems, lighting fixtures, pipes, ducts, elevators, escalators, sprinkler systems, fire escapes and other components relating to the operation or maintenance of a building.” Id. § 1.897-1(b)(3)(iv).
[13] Treas. Reg. § 1.897-1(b)(2). “Property used in mining, farming, and forestry” is personal property predominantly used to exploit unsevered natural products in or upon the land and includes 1) mining equipment used to extract ores, minerals, and other natural deposits from the ground; and 2) any property used to cultivate the soil and harvest its products, such as farm machinery, draft animals, and equipment used in the growing and cutting of timber. Treas. Reg. § 1.897-1(b)(4)(i)(A). The term doesn’t include personal property used to process or transport minerals, crops, or timber after they are severed from the land. Id. § 1.897-1(b)(4)(i)(A).
[14] Treas. Reg. § 1.897-1(b)(2). “Property used in the improvement of real property” includes personal property predominantly used to construct or carry out improvements to real property and includes equipment used to alter the natural contours of the land, equipment used to clear and prepare raw land for construction, and equipment used to carry out the construction of improvements. Id. § 1.897-1(b)(4)(i)(B).
[15] Treas. Reg. § 1.897-1(b)(2). “Property used in the operation of a lodging facility” includes personal property predominantly used in the living quarters of a lodging facility, including “beds and other furniture, refrigerators, ranges and other equipment, as well as property used in the common areas of such facility, such as lobby furniture and laundry equipment.” Id. § 1.897-1(b)(4)(i)(C). A “lodging facility” means “an apartment house or apartment, hotel, motel, dormitory, residence, or any other facility (or part of a facility) predominantly used to provide, at a charge, living and/or sleeping accommodations, whether on daily, weekly, monthly, annual, or other basis.” Id.
[16] Treas. Reg. § 1.897-1(b)(2). “Property used in the rental of furnished office and other workspace” includes personal property predominantly used by a lessor to provide furnished office or other workspace to lessees and includes office furniture and equipment included in the rental of furnished space. Id. § 1.897-1(b)(4)(i)(D).
[17] Id. § 1.897-1(b)(4)(ii)(A).
