As anyone who pays attention to business and real estate trends knows, the Qualified Opportunity Zone (QOZ) program was passed as part of the Tax Cuts and Jobs Act of 2017, in an attempt to encourage investment of capital gains in lower-income areas, in return for some pretty nifty tax breaks.
While the focus has been on U.S. investors and capital gains acquired from the sale of assets, one question that comes up is whether foreign investors are eligible for qualified opportunity zones. Or rather, whether non-U.S. residents or businesses can take advantage of capital gains tax deferrals through involvement with the QOZ program.
According to the IRS, the basic answer to this question is “yes,” as follows:
“Nonresident alien individuals and foreign corporations may generally elect to defer eligible gains that are otherwise subject to federal income tax in their hands. For example, this includes gains that are effectively connected to a U.S. trade or business and capital gains from the disposition of a U.S. real property interest by a nonresident alien individual or a foreign corporation.”
However, as is the case when it comes to the IRS, the actual answer is much more complex.
On the one hand, according to an article in Bloomberg Tax, foreign investors can participate in Qualified Opportunity Zones through “blocker” corporations, which are U.S. or foreign entities classified as corporations for U.S. income tax purposes; it is the corporation, rather than the investor, that has capital gains to invest. Foreigners can also participate as partners in a partnership (as long as that partnership isn’t formed to skirt any kind of tax rules).
As is the case with domestic entities, any entity subject to taxes on capital gains from the disposition of a U.S. property can invest capital gains into a QOZ to defer taxation. However, only foreign investors -- such as institutional investors or eligible businesses with capital gains from selling a U.S. business or piece of real estate might qualify. Tax-exempt institutional investors, such as endowments or pension funds, aren’t eligible.
But here is where the situation gets a little tricky. The IRS noted that “if the gain would be exempt from federal income tax under an applicable income tax treaty,” the foreign entity involved with that sale would need to waive that treaty’s benefits to take advantage of any kind of tax deferral program.
Additionally, any foreign entity selling U.S. property needs to pay attention to Public Law 96-499, Subtitle C. Dubbed “Taxation of Foreign Investment in United States Real Property,” this section is better known as the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA. FIRPTA presents a whole list of how foreign entities will be taxed on U.S. property sales, including a section on withholding requirements.
Making the long (FIRPTA) story short, while the sale of a property is subject to capital gains taxes, the IRS isn’t allowing foreign investors to avoid withholding by investing in Qualified Opportunity Zones. This, in turn, means that, while foreign entities can certainly participate in such investments, there is little or no tax incentive for them to do so.
As of now, no changes are proposed to provide a better connection between FIRPTA regulations and the QOZ program. However, officials did write in the rules that they would “continue to consider” how the withholding situation could work in tandem with opportunity zone investments.
In the meantime, some foreign money is coming into QOZs under current rules. Reid Thomas with NES Financial told Bloomberg Tax that some foreign investors are investing in QOZs without the tax benefits. These investors believe that government-subsided growth will mean additional capital flowing to those neighborhoods. But the potential tax deferral carrot, dangled in front of many U.S. entities, isn’t a factor in such decisions by foreign investors.
Overall, there is nothing in the QOZ rules that prohibits any kind of foreign investment, as long as that investment is in the form of capital gains. But the issue is that, from a tax-deferral perspective, there’s no incentive for a foreign entity to participate in the program.
For additional information about Qualified Opportunity Zone investments, contact Realized Holdings by logging on to realized1031.com, or by calling 877-797-1031.
There are material risks associated with investing in QOZ properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results.
Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. There is no guarantee that the investment objectives of any particular program will be achieved.