Thomas C. Roberge & Company

1031 EXCHANGES AND FOREIGN INVESTORS

UNIQUE CONSIDERATIONS

March 5, 2007

St. Petersburg and Sarasota

Telephone: (727) 822-9393

Each week we receive numerous questions from real estate professionals regarding the ability of foreign investors to transact Section 1031 exchanges. These types of transactions are also commonly referred to as “Starker”, tax deferred or tax free exchanges of real estate.

The short answer is that a foreign investor can structure a “1031” transaction as long as they meet the normal, statutory requirements for such an exchange. However, “1031” exchanges may not always be as desirable for foreigners as they are for domestic investors because of special U.S. tax rules and the home country tax consequences of these transactions.

The first obstacle for a “1031” transaction for a foreign investor is that the exchange is subject to the 10% FIRPTA withholding and almost always is not eligible for a “Notice of Nonrecognition” for purposes of avoiding FIRPTA. The IRS will issue a withholding certificate for a like-kind exchange, but the 10% withholding will have to stay in the closing agent’s escrow account for the four to six months it takes for the IRS to process the withholding certificate application. This means that the seller may have to raise additional capital to complete the exchange.

The second roadblock is that many countries do not respect the deferral aspect of a “1031 exchange” and will tax the gain currently even though U.S. tax law defers the tax. This means that the entire capital gains tax can be payable in the seller’s home country with no current offset for U.S. taxes in the year of the exchange. This often creates serious long-term tax problems in the seller’s home country. The potential long-term tax problems can be quite severe and are beyond the scope of this article. In summary, your foreign investor should definitely obtain home country tax advice before consummating a “1031” exchange. Our firm has extensive experience in working with foreign tax professionals in evaluating the desirability of these transactions.

The last issue - especially for foreign investors – is that the long-term tax rate on capital gains presently is only 15%. If a foreign investor consummates a “1031 exchange”, the tax rate on the deferred gain will likely be the tax rate in effect in a future year when the deferred gain is eventually taxed. We can remember when the long-term tax rate on capital gains was 28% and 35%. This opens the possibility for a deferred “1031” gain to be taxed at a higher rate in the future than at the 15% rate today. Let’s face it – 15% is pretty cheap compared to most countries. Your foreign investor may feel good about being able to keep 85% of the profit today compared to only 65% or less in the future if Congress decides to raise taxes to cover budget deficits, bail out social security, etc.

Let’s realize it – the U.S. is a great place to invest and will continue to be. The tax rates are structured favorably to accomplish this. The adjustment presently going on in the real estate market is offering opportunities to buyers and sellers like we have not seen for many years. The “key” to success in this type of market is patience and getting tax advice before the transaction is consumated.

Internal Revenue Service Circular 230 Disclosure – You are hereby advised that any tax advice contained in this newsletter is not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or to support the marketing of any tax transactions or matters addressed herein.