The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) was signed into law on Dec. 18, 2015, as part of the Consolidated Appropriations Act, 2016. The PATH Act alters the regime for taxing foreign persons holding U.S. real estate and the taxation of real estate investment trusts (REITs). In addition, the PATH Act includes numerous changes to provisions that had expired at the end of 2014. Some of these provisions have been extended for an additional period of time, while others have been made permanent. Below is an explanation of some of the major changes included in the Act.
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) treats a foreign person’s gain or loss from the disposition of a U.S. real property interest (USRPI) as income that is effectively connected with the conduct of a U.S. trade or business, and thus it is taxable at the income tax rates applicable to U.S. persons, including the rates for long-term capital gains. The following reforms to FIRPTA were made by the PATH Act:
- The maximum percentage of stock a foreign person may hold in a publicly traded REIT that is a U.S. real property holding corporation (USRPHC) without such stock being considered a U.S. real property interest has been changed from 5 percent to 10 percent.
- The exclusion of domestically controlled regulated investment companies (RICs) from the definition of a USRPI has been made permanent.
- Any USRPI held directly (or indirectly through a partnership) by certain foreign pension funds or entities wholly-owned by such foreign pension funds, as well as any distribution from a REIT received by such pension funds or entities, are now exempt from FIRPTA.
- The cleansing rule, under which interests in a USRPHC become a non-USRPI, is not applicable if the USRPHC was a RIC or a REIT.
- Distributions from a RIC or REIT may not be treated as distributions from a U.S. corporation for purposes of determining whether the distribution qualifies for the dividends received deduction.
- The withholding rate on dispositions and certain distributions of USRPIs has been changed from 10 percent to 15 percent. However, the 10 percent withholding rate is retained for property that the buyer intends to use as a personal residence if the purchase price does not exceed $1 million, and purchases of personal residences with a purchase price of $300,000 or less continue to be exempt from FIRPTA withholding.
The taxation of REITs has also been altered by the PATH Act. The following changes have been made to the rules concerning REITs:
- Newly created REITs are now ineligible to participate in a tax-free spin-off under Section 355 of the Code, unless both the distributing and controlled corporation are REITs.
- The allowable percentage of REIT assets that may consist of securities in a taxable REIT subsidiary has been reduced from 25 percent to 20 percent.
- The maximum amount of property a REIT may sell under the prohibited transaction tax safe harbor has been increased from 10 percent of REIT assets to 20 percent, provided sales for the year do not exceed 10 percent of the three-year rolling average fair market value or basis of assets owned by the REIT.
- Publicly traded REITs may now offer preferred stock without losing the deduction for dividends paid to shareholders.
Controlled Foreign Corporations
The PATH Act permanently extends the exception from foreign personal holding company for income earned by a controlled foreign corporation (CFC) in the active conduct of a banking, financing or similar business, securities dealing business or insurance business. The Act also extends until Dec. 31, 2019 the look-though rule for payments between related CFCs, which provides that a payment of dividends, interest, rents or royalties by a CFC to a related CFC are not treated as foreign personal holding company income to the extent the payment is not attributable to Subpart F income or income effectively connected with a U.S. trade or business of the payor.
The PATH Act permanently changes the recognition period from 10 years to five years for built in gains of S corporations that convert from C corporation status or acquire appreciated assets of a C corporation in a carryover basis transaction. This change also applies to REITs and RICs that were formerly C corporations if the entities do not elect deemed sale treatment.
The PATH Act makes permanent the deduction allowed under Section 179 of the Internal Revenue Code for certain property newly placed in service. The maximum amount that may deducted in any year is $500,000 (indexed for inflation), and the deduction is phased out dollar for dollar to the extent assets placed in service exceed $2 million (indexed for inflation). In addition, the Act extends the deduction for bonus first-year depreciation until Dec. 31, 2019.
Additionally, the PATH Act makes a number of changes to certain credits, deductions and exclusions, many of which affect low- and middle-income taxpayers. Among these changes are:
- The new markets tax credit for qualified equity investments in a qualified community development entity has been extended through 2019.
- The work opportunity credit available to employers that hire certain employees has been extended through 2019.
- The exclusion from gross income of the gain recognized on the sale of Qualified Small Business stock held for more than five years has been made permanent.
- The increased percentage limit and extended carryover period for the deduction of qualified conservation contributions has been made permanent.
- Distributions from a 529 plan may now be used to purchase computer and peripheral equipment, computer software, or internet access and related services if such equipment, software or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible education institution.
- The enhanced earned income tax credit, child care credit and American opportunity tax credit have been made permanent.
- The deduction for mortgage insurance premiums has been extended until Dec. 31, 2016.
- The exclusion from gross income of discharge of qualified principal residence indebtedness has been extended until Dec. 31, 2016.
- The filing date for Form W-2 has been changed to Jan. 31.
- Certain health insurance taxes have been suspended or delayed.