Senate Draft Tax Provisions Impacting REITs and Foreign Investors

Key Provisions and Implications

Permanent Extension of the Qualified Business Income Deduction for REIT Dividends

The Senate Bill would make permanent the current 20% deduction for qualified REIT dividends under Section 199A. This provision, which was originally enacted to provide parity between REITs and other pass-through entities, is currently scheduled to expire for taxable years beginning after December 31, 2025. By eliminating the sunset provision, the Senate Bill would preserve the deduction, and the maximum effective top federal tax rate of 29.6% on ordinary REIT dividends for individuals, trusts, and estates. Notably, the Senate Bill does not increase the deduction percentage to 23%, as proposed in the House Bill, but nonetheless provides long-term certainty for REIT investors by making the 20% deduction permanent.

Retaliatory Tax Measures: New Section 899 and Repeal of Section 892 Exemption

The Senate Bill, consistent with the House Bill, introduces a new Section 899, which would impose retaliatory tax measures on persons from “offending foreign countries” (“OFCs”) that impose “unfair foreign taxes” on U.S. persons or their controlled foreign corporations. The retaliatory taxes would be incremental additional taxes that apply on top of the existing tax rates that would otherwise apply. Section 899 would also repeal the Section 892(a) exemption for foreign governments (including sovereign wealth funds) of such jurisdictions.

Under Section 899, U.S. tax rates imposed on “applicable persons” would increase by 5% in the year following the one-year anniversary of enactment, with additional 5% increases each subsequent year, up to a maximum increase of 15% above the current applicable rate (including treaty rates). “Applicable persons” would include foreign governments of OFCs, non-U.S. individuals and foreign corporations that are tax residents in OFCs, certain non-public foreign corporations majority-owned by such persons, certain foreign private foundations and trusts, and other entities identified by the Secretary of the Treasury as connected to an OFC.

The increased tax rates would apply to:

• Withholding taxes on dividends, interest, royalties, rent, and other fixed or determinable annual or periodic (“FDAP”) income (currently 30% unless reduced by treaty);
• Income effectively connected with a U.S. trade or business (“ECI”), including gains subject to the Foreign Investment in Real Property Tax Act (“FIRPTA”);
• FIRPTA withholding on dispositions of U.S. real property (currently 15%);
• The branch profits tax; and
• Investment income earned by non-U.S. private foundations.

The Senate Bill differs from the House Bill in that it delays the application of Section 899 until no earlier than January 1, 2027, and limits the maximum increase to 15% above the currently applicable rate, ensuring that treaty investors are not subject to taxes exceeding 15% above their treaty rate. In contrast, the House Bill would have permitted increases up to 20% above the statutory rate, potentially subjecting treaty investors to the same rates as non-treaty investors.

The repeal of the Section 892(a) exemption would subject foreign governments of OFCs (including their sovereign wealth funds) to U.S. tax and withholding on U.S.-source passive income, including REIT dividends, at the generally applicable rates (including the increased rates under Section 899), unless relief is provided by an applicable tax treaty. This change could result in significant new U.S. tax liabilities for sovereign wealth investors from OFCs. However, the Senate Bill retains the exemptions for “portfolio interest” and for FIRPTA gains realized by qualified foreign pension funds, which may continue to provide relief for certain foreign investors.

Business Interest Deduction Limitation (Section 163(j))

Section 163(j) currently limits the deduction for business interest expense to 30% of a taxpayer’s adjusted taxable income. For taxable years beginning before January 1, 2022, adjusted taxable income was calculated without regard to deductions for depreciation, amortization, or depletion (i.e., on an EBITDA basis). Since 2022, the limitation has been based on EBIT, reducing the amount of deductible interest expense.

The Senate Bill proposes to permanently restore the EBITDA-based calculation of adjusted taxable income, thereby increasing the amount of business interest expense that can be deducted. This change would provide a more favorable outcome for taxpayers compared to the current law. Unlike the House Bill, which would sunset this change after five years, the Senate Bill would make the EBITDA approach permanent.

Taxable REIT Subsidiary (“TRS”) Asset Test

The House Bill proposed to increase the limit on the value of securities of TRSs that a REIT may hold from 20% to 25% of the value of its assets, effective for taxable years beginning after December 31, 2025. This adjustment was intended to provide REITs with greater structural flexibility and to ease compliance burdens, particularly for those with significant TRS operations and foreign assets. The Senate Bill, however, does not include this proposal and the current 20% limitation would remain in effect.

Conclusion

The Senate Bill introduces several significant tax provisions that would impact REITs and their shareholders, particularly foreign investors. While some changes are positive, like the permanent extension of the qualified business income deduction for ordinary REIT dividends and the restoration of the EBITDA-based business interest deduction limitation, the introduction of retaliatory tax measures against certain foreign investors and the repeal of the Section 892 exemption for foreign governments of OFCs are likely to be the most consequential changes for REITs. REITs with foreign investors, especially those from OFCs, should carefully consider the potential impact of these provisions on their structures and may want to explore planning opportunities to mitigate increased tax exposure, such as the use of leveraged blocker structures or other tax-efficient vehicles. As the legislative process continues, stakeholders should monitor developments closely and consult with tax advisors regarding the evolving landscape.