We previously blogged that the Florida Legislature enacted a reduction to the state sales tax rate on commercial real property leases from 6% to 5.8% effective January 1, 2018. The language of the new statute is unclear as to whether the rate decrease would apply to current leases. However, we have confirmed with a representative of the Florida Department of Revenue that they interpret the rate reduction as applying to current leases for periods after December 31, 2017.
Governor Rick Scott signed House Bill 7109 on May 25, 2017, which reduces the state sales tax rate on commercial real property leases from 6% to 5.8% effective January 1, 2018. However, this rate decrease will not apply to current leases, because the bill provides that the tax rate in effect at the time the tenant occupies or uses the property is applicable, regardless of when a rent payment is due or paid. The bill does not change the local option sales tax, which is imposed in 0.5% increments. So, for example, the applicable rate in Sarasota County for leases commencing on or after January 1, 2018, would be 6.8% (instead of the current 7%). Florida is the only state that charges sales tax on the lease of commercial real property.
The Canada Revenue Agency (“CRA”) announced at the May 26 meeting of the International Fiscal Association in Montreal that limited liability limited partnerships and limited liability partnerships organized under the laws of Florida or Delaware will be taxable as corporations for Canadian income tax purposes. The CRA has treated US limited liability companies as corporations for many years, but previously treated US LLLPs and LLPs as pass-through entities. The announcement did not specify whether similar entities organized in other US states would be treated the same, but the justification provided by the CRA would appear to apply to such other entities.
The CRA’s announcement raises several issues for US LLLPs and LLPs that have Canadian owners, including such entities that own US real estate. One issue is that income from these entities will now be subject to double income tax. The US will treat these entities as pass-through entities and so only the owners will be subject to US income tax, but Canada will now treat these entities as corporations. Consequently, Canadian dividend tax will apply to distributions received by the Canadian owner, and a Canadian tax credit is not available for the US tax. Previously for such LLLPs and LLPs, but not for LLCs, the Canadian owner could credit the US tax they paid against their Canadian tax. Issues can also arise for US LLLPs or LLPs that do not have Canadian owners, but have business operations or investments in Canada.
The CRA did announce transitional relief so that US LLLPs and LLPs can be treated as pass-through entities for Canadian tax purposes retroactively if certain conditions are satisfied. One of the key conditions is that the LLLP or LLP must convert before 2018 to an entity that is recognized by the CRA as a pass-through entity, such as a general partnership or a limited partnership.
Real estate developers routinely use tax-exempt bond financing for infrastructure improvements for new communities. That may change soon. IRS perceives abuse in the process, and has proposed regulations making such bonds taxable if the developer controls the issuing governmental body.
Using enabling statutes under state law, a developer can initiate creation of a governmental body with the power to issue bonds secured by the developer’s land. Although other types exist, Community Development Districts (often called “CDDs”) are the most common governmental body formed this way in Florida.
Such governmental bodies have historically qualified to issue municipal bonds exempt from federal income tax. Because investors demand a lower absolute interest rate from tax exempt bonds than taxable bonds, these structures allow developers to enjoy a lower financing cost than would otherwise be the case.
The governing officials for such bodies usually are elected through a voting process weighted based on land ownership. In the early phases of development, the developer owns most or all of the land, and therefore controls the governmental body. When the neighborhood is closer to completion–and end-users have purchased lots and other developed property–the developer loses control, and the new property owners oversee the governmental body.
The problem with the IRS proposed regulations is that the developer always controls the governmental body when making the initial infrastructure improvements–such as roads and utility infrastructure–for a community. At that time, there is no community in which end users can buy lots, homes, or other property. By prohibiting developer control, the proposed regulations could eliminate–or severely restrict–this form of financing.
The IRS is considering taxpayer comments suggesting an exemption from the new rules for early-stage developments under developer control. This may provide a middle ground that limits abuse, but permits legitimate infrastructure improvements by governmental bodies that are reasonably expected to eventually be controlled by a widely disbursed group of end-user owners. As usual, the devil is in the details. For example, it may be difficult to fit larger, multi-phase communities within such rules. Unfortunately, with these proposed regulations, the IRS has put the burden on taxpayers, rather than itself, to design a workable framework. Comments are due to IRS by May 23.
Here is a link to the proposed regulations: https://www.irs.gov/irb/2016-10_IRB/ar17.html
There are various ways to structure a foreign investment in US real property and each has its own advantages and disadvantages (see below for a link to a previous blog post on this topic). A frequently chosen structure is a pass-through or fiscally transparent structure which, very generally, has income tax advantages (especially upon a disposition of the property), but US estate tax disadvantages. Over time, however, clients age and their plans change, and so we are sometimes called upon to convert a pass-through structure to a structure with US estate tax advantages (i.e., typically by inserting a foreign corporation into the structure), but which has income tax disadvantages. Converting such structures can at first blush seem relatively simple, but there are several traps for the unwary. A common approach to converting such structures is for the foreign client to contribute their ownership interests in the US pass-through entity (such as a partnership or LLC taxed as a partnership or disregarded for federal income tax purposes) to a foreign corporation. Normally, such a transaction would be tax-free under IRC section 351 as a contribution to the capital of a corporation. However, FIRPTA complicates the picture. Specifically, FIRPTA rules add additional requirements in order for this transaction to be tax-free, including that the ownership interest in the US pass-through entity (which is considered a US real estate property interest (“USRPI”) for FIRPTA purposes), be exchanged for another USRPI. Stock of a foreign corporation is generally not a USRPI, and therefore the contribution of the ownership interests in the pass-through entity to the foreign corporation would be considered a taxable sale. There are at least two planning techniques to avoid this issue that involve the use of a US corporation or having the foreign corporation elect to be treated as a US corporation for federal income tax purposes, but both techniques have their own set of advantages and disadvantages that must be carefully considered.
A previous blog post on structuring options for foreign investment in US real estate can be found here:
Reversing the US Tax Court, the US Court of Appeals for the Eleventh Circuit recently held that a real estate developer recognized long-term capital gain when he sold contractual purchase rights in real estate, even though the developer previously intended to develop and resell the underlying real estate as condominiums. The Court found that contractual purchase rights could be a capital asset even though the real estate itself would have become ordinary income generating inventory property had the developer closed the purchase contract instead of selling it. As a result, the developer’s effective tax rate was probably reduced by approximately 20%.
The case bolsters some capital gain preservation tax strategies. It does not, however, provide a blank check to lock in capital gain tax rates by trading in contracts rather than land. A few warnings:
First, the circumstances of the sale deviated from the developer’s original plan. While the Court’s reasoning is not entirely clear, the Court observed that the developer did not originally intend to sell the contractual rights. Instead, the developer originally intended to close on the contract, purchase the real estate, and develop condominiums for resale. The tax result could be different if the developer planned all along to sell the purchase contract itself.
Second, the Eleventh Circuit is a federal appellate court immediately below the Supreme Court, with jurisdiction over Florida, Alabama, and Georgia. It is unlikely the Supreme Court will hear this case. While other federal courts with jurisdiction elsewhere might find the Eleventh Circuit’s decision persuasive, they could reach different conclusions. The Tax Court reached a different conclusion in the same case. The Eleventh Circuit’s conclusion is most helpful to taxpayers subject to the Eleventh Circuit’s appellate jurisdiction. Other taxpayers face greater risks relying on the Eleventh Circuit’s decision.
Here is a link to the Eleventh Circuit’s opinion in Long v. Commissioner:
Here is a link to the Tax Court’s decision in the same case, which the Eleventh Circuit reversed on this issue:
On behalf of a client, Williams Parker recently obtained a Technical Assistance Advisement from the Florida Department of Revenue (the “Department”) that leases of nursing homes and assisted living facilities are exempt from sales tax to a greater degree than currently provided in the Florida Administrative Code. Oftentimes, the operator of a senior living facility leases the real estate from another legal entity, which may or may not be related. In interpreting the statutory exemption for leases of residential facilities for the aged, the Florida Administrative Code provides that only the areas of a senior living facility that are accessed and used by residents (excluding, for example, the kitchen portion of a cafeteria and administrative office areas) are exempt from sales tax. However, a trial court opinion (from the 18th Circuit Court for Brevard and Seminole counties) held that all areas of senior living facilities (not just those areas accessed and used by residents) are exempt, except for those areas leased for separate commercial purposes, such as a portion of the facility leased to a bank or hair salon. The Technical Assistance Advisement obtained by Williams Parker (i) affirms that the Department will follow the holding of the trial court outside of the 18th Circuit, and (ii) extends the holding of the trial court to leases of equipment and other tangible personal property owned by the landlord and used by the operator of the facility, at least where the lease is silent regarding any separate consideration for the tangible personal property.
A copy of the Technical Assistance Advisement can be found here: https://revenuelaw.state.fl.us/LawLibraryDocuments/2014/05/TAA-118253_14A-012%20redacted%20_%20summary%20RLL.pdf
If you have any questions regarding the Technical Assistance Advisement or other questions regarding Florida taxes, please contact:
Foreigners, especially Canadians, continue to comprise a significant percentage of Florida real estate purchases. The National Association of Realtors reported that during the recent 12-month period ending July 2013 the total sales volume of Florida residential real estate purchases by foreigners was $6.4 billion (9% of total Florida residential sales volume). 30% of these foreign purchasers were Canadian. These figures do not included foreign purchases of commercial real estate. Unfortunately, many Canadians and other foreign real estate purchasers do not sufficiently consider the U.S. tax ramifications of their purchase. There are many alternatives for structuring a foreigner’s purchase of U.S. real estate, and each alternative has tax advantages and disadvantages.
Below is a link to an article that discusses the U.S. tax issues and planning techniques that can help minimize tax headaches for Canadian (and other foreign) owners of Florida real property.
If you need assistance with a foreign purchaser of U.S. real estate, please contact us.