The Internal Revenue Service this week put off a deadline under which foreigners who own American real estate must choose either to disclose their holdings or to set up a security agreement with the IRS to cover any potential capital gains tax they might incur.
The choice between disclosure, which could be awkward for many foreigners, and posting what could be a very large security deposit is causing widespread unhappiness among foreign investors, according to some lawyers, brokers, accountants and others in the real estate field.
The deadline for applying for a security agreement was to have been last Monday, but the IRS has postponed that until the agency is able to write permanent regulations. The law imposing the requirements was passed in 1980, but so far the IRS has promulgated only temporary rules.
Harrison Wellford, a Washington attorney and former Carter administration official, foresees a "chilling effect" on foreign investment in this country. He said the measure should be viewed "in the larger context of the protectionist fervor" now evident on Capitol Hill that he feels many foreigners will find alarming.
Jose A. Diaz-Asper, a Coral Gables, Fla., attorney whose firm has a number of foreign clients who are real estate investors, agrees. "A lot of foreign taxpayers feel that they're being singled out and possibly that their investment is not wanted in this country anymore," he said.
On the other hand, Graham Bond of the international real estate consulting firm of Richard Ellis, which represents large institutional investors, most of them British, said his clients regard the law as "just another complication" of the sort investors encounter whenever they operate outside their own country. "It is simply a matter one has to confront and move on," and not a significant disincentive to investment, he said.
The requirements are part of the Foreign Investors Real Property Tax Act of 1980, which was designed to change provisions and close loopholes in the tax code that permitted many transactions involving foreign-owned real estate to escape U.S. taxes.
"I think everybody I've talked to is in agreement that this was basically a good piece of legislation--that we should have a tax on the disposition of real property," said Diaz-Asper. "There was a lot of abuse because foreigners were able to get tax-free capital gains. . . . But the way Congress went about it perhaps leaves a lot to be desired."
The law has two basic thrusts, according to tax practitioners. On the one hand, it changes the way capital gains are treated, and redefines what is and is not a taxable event for foreigners and for partnerships and corporations involving foreigners. For instance, it restricts the way instalment sales can be used to escape taxes and also makes swaps of U.S. and foreign property taxable (though trades of similar U.S. properties still may be done tax-free).
On the other hand, it requires U.S. companies with foreign owners, foreign companies with U.S. holdings, and foreign individuals with U.S. holdings--even indirect ones--worth more than $50,000 to file informational returns with the IRS.
"Congress felt that foreign investors were not a good risk" and therefore enacted a law "that in effect created the presumption that the foreign taxpayer might not pay his tax so we are going to try to get that tax by . . . identifying who the foreign taxpayer is," Diaz-Asper said.
This approach is making the foreigners unhappy. In many cases, "They don't want their governments back home to know they're here," Diaz-Asper said."Anonymity is very important to them. . . . So what the IRS did is take that issue and create one way out," the security agreement.
Under this arrangement, a foreigner could provide some form of security, such as a lien on the property, either through a bank or directly with IRS, funds or other property in escrow, letters of credit, or a bond. Deciding whether a particular form of security is acceptable is left to the discretion of the IRS.
"The problem with the security agreement is that you're dealing with an investor who has not disposed of his property. You are in fact creating a tax where there is no tax, because the capital gain would not be realized until the taxpayer sold the property," Diaz-Asper said.
He pointed to the problem of a timber or paper company, for example, which might have extensive land holdings that it has no intention of selling. But if it did sell, the tax liability would be enormous, and would have to be covered by the security agreement.
He said an accountant in Houston told him of computing a client's potential tax liability and finding that it exceeded $100 million. "There's no way in the world he could cover that," Diaz-Asper said.
Wellford emphasized that "the uncertainty surrounding the implementation of the whole act" is one of the biggest problems. "Investment always reacts to uncertainty," and "there are plenty of other places" it can go," he said.