Liquid assets lost in investment companies under FIRPTA rules.

• Author: Dubert, Carl
• Position: Foreign Investments in Real Property Tax Act of 1980

A foreign-owned U.S. corporation with significant U.S. real property holdings should not transfer liquid assets to a subsidiary without first examining the potential consequences under the Foreign Investments in Real Property Tax Act of 1980 (FIRPTA) rules.

Under FIRPTA, a foreign person is generally subject to U.S. tax on any gain realized on disposition of a U.S. real property interest (USRPI) (Sec. 897(a)). An equity interest in a domestic corporation generally constitutes a USRPI if the domestic corporation qualifies as a U.S. real property holding company (USRPHC), or qualified at any time during the five-year period preceding the disposition (Sec. 897 (c) (1) (A) (ii)). A corporation qualifies as a USRPHC whenever the fair market value (FMV) of its USRPI holdings equals at least 50% of the FMV of its USRPI holdings, its foreign real property holdings and its trade or business assets (Sec. 897(c)(2)).

A corporation's trade or business assets include only assets used or held for use in the corporation's business operations (i.e., assets held for the principal purpose of promoting the present conduct of the trade or business, acquired and held in the ordinary course of the trade or business or otherwise held in a direct relationship to the trade or business). An asset is held in a direct relationship to a trade or business when it is needed in the trade or business; an asset is considered to be so needed only if it is held to meet present business needs and not anticipated future needs (Kegs. Sec. 1.897-1 (f)).

Whether particular assets qualify depends on the facts and circumstances. This analysis is especially difficult in the case of liquid assets (e.g., cash, receivables and marketable securities), because of the subjective nature of any determination of the amount of liquid assets currently needed in a particular trade or business (as opposed to the amount held for anticipated future use). For this reason, Regs. Sec. 1.897-1(f)(3) provides a safe harbor: Liquid assets may be considered trade or business assets in an amount up to 5% of the FMV of all other trade or business assets. Thus, for example, if a corporation has nonliquid trade or business assets valued at $100 and cash of $10, the corporation may consider $5 of the cash as a trade or business asset, so that the corporation has trade or business assets totaling $105.

"Look-Through" Rule

A corporation's liquid assets generally include any stock that a corporation may own...