FIRPTA - A Practical Approach to the Valuation Exercise

An often unknown yet potentially costly tax can emanate from the Foreign Investment in Real Property Tax Act, known as “FIRPTA.” In the following, we discuss a pragmatic approach to the valuation exercise, which is a key part of a FIRPTA analysis.

What Is FIRPTA?

FIRPTA authorizes the Internal Revenue Service to tax non-resident persons or corporations on dispositions of the United States (U.S.) Real Property Interests (USRPIs) when the corporation that owns the USRPIs is deemed to be a U.S. Real Property Holding Corporation (USRPHC). A corporation is defined as a USRPHC when the Fair Market Value (FMV) of its USRPIs on any applicable determination date equals or exceeds 50.0 percent of the sum of the FMVs of its:

1. USRPIs; ¹
2. Interests in real property located outside the United States; and
3. Any other assets that are used in a trade or business or held for sale.

When a corporation is deemed to be a USRPHC, the foreign transferor is subject to a withholding tax. Understanding the FMV of the USRPIs throughout the measurement period is therefore of the utmost importance.

Start With a High-Level Approach

Valuations conducted for FIRPTA purposes can be complex, time-consuming endeavors that require a significant amount of effort and data from the company. Rather than immediately conducting an in-depth valuation exercise, a more pragmatic approach is to initially perform a higher-level analysis. This may allow the company to avoid expending the time and costs for a valuation engagement that ultimately provides no meaningful insights, where the conclusions simply point out the obvious, especially as there is no need to provide a valuation to support the finding of a company being a USRPHC (the taxpayer must support their position only if deeming the company to not be a USRPHC). This preliminary analysis will yield one of three results:

1. Definitely a USRPHC: In certain situations, it will be immediately obvious that the FMV of the USRPIs exceeds the 50.0 percent threshold, and the company is deemed a USRPHC. No additional valuation analyses are required.
2. Definitely not a USRPHC: In certain situations, it will be immediately obvious that the FMV of the USRPIs does not equal or exceed the 50.0 percent threshold, and the company is not deemed a USRPHC. In some cases, we have still been requested to conduct a full valuation analysis and issue a detailed, narrative report. In other cases, no further analyses are conducted, and the requested deliverable is a summary narrative describing why the 50.0 percent threshold clearly is not met (i.e. the company is not a real property intensive business, the FMVs of the USRPIs based on the high-level analyses are not anywhere close to 50.0 percent of the total asset value, etc.). 
3. Unclear, further analysis required: In all other scenarios, it will not be immediately clear whether the company meets the criteria of a USRPHC. This is often a function that the preliminary range of the USRPI FMVs is somewhere in the vicinity of 50.0 percent of the FMV of the total assets. In every one of these cases, we have been asked to conduct a full valuation analysis and issue a detailed, narrative report that concludes on the FMV of all USRPIs as a percentage of its total USRPIs, interests in real property located outside of the United States, and any other assets that are used in a trade or business, or assets held for sale. 

We note there are some cases in which we are requested to proceed directly to conduct a full valuation analysis and issue a detailed, narrative report. In our experience this is driven by a desire by some parties to have as much formal documentation as possible regardless of the FMV results, in other situations the available data are simply not sufficient to perform a high-level analysis, additionally, there are times when a high-level analysis will not provide sufficient insight given the specific nature of the USRPIs and a detailed analysis is required.

Identifying USRPIs

Identifying if an asset is a USRPI is not always clear-cut. Some assets are readily identifiable as either being a USRPI or not, while for other assets it may not be so clear. One of the first steps in the valuation process is to have the tax advisor categorize each of the company’s asset classes into one of the following:

1. Definitely a USRPI
2. Definitely not a USRPI
3. Possibly a USRPI

By first identifying the characteristics of each asset class, this approach enables a streamlined engagement process while also providing insight regarding the FMVs of the USRPIs relative to the 50.0 percent threshold, with and without assets that may be considered “Possibly a USRPI.” The valuation focus can then be heavily placed on the assets that are definitely or possibly USRPIs.

Five-Year Period

The determination of whether a corporation is a USRPHC has a five-year window (unless the actual holding period is shorter). Thus, when trying to determine the status of a company with current foreign ownership, the USRPIs and total assets must be valued over a five-year lookback period from the date of disposition. The company is deemed a USRPHC if the FMV of the USRPIs is greater than 50.0 percent of the total assets at any given point during the measurement period. As this increases the complexity of the valuation analysis, it is important to first outline the exact time intervals over the five-year period – i.e., once per month, etc. – that the USRPIs and total assets will be valued throughout the lookback period. Identification of any date on which the FMV of the USRPIs approaches the 50.0 percent threshold could warrant even further analysis around that time period.

While the proposed purchase consideration can be used as a basis for the denominator in the equation for the current valuation, estimating the FMV of the company over the prior five years introduces a significant number of complexities and variables for consideration. First and foremost, transactions of the company’s equity, as well as any valuation of the company, equity interests, etc., must be considered and incorporated into the FIRPTA valuation to avoid having the respective values contradict each other. The performance of the company, the historical, prevailing and projected financial results, the values of publicly traded comparable companies, prices paid to acquire comparable companies, prevailing economic conditions, and other relevant factors that affect the value of the company must be considered in each of the valuations throughout the entire measurement period. As measuring value on a monthly basis will result in 60 separate valuations of the overall company, it is important to develop a pragmatic yet supportable approach to estimating FMVs on that many dates.

We must keep in mind that the above only addresses estimating the FMV of the overall company throughout the five-year lookback period. The USRPIs must also be valued at each of the same valuation dates, which again necessitates a practical approach to valuing these assets, all while ensuring that the valuation analysis is fully supportable.

In valuing the USRPIs over the five-year period, there can be a considerable number and wide variety of properties that could represent a sizable undertaking, especially with regard to the prevailing market conditions at each valuation date and the specific characteristics of each property. Furthermore, any requirements to value personal property assets that are associated with real property introduce even further complexities, especially when considering the need for access to detailed financial data regarding these personal property assets at each valuation date over the past five years.

It is worth mentioning that in addition to valuing the USRPIs, some high-level analyses should be conducted regarding the FMVs of the non-USRPI assets, i.e. personal property not associated with the use of real property, intangible assets, etc. This crosscheck should be prepared to ensure that the FMV of the sum of all assets reconciles, within reason, to the FMV of the overall company.

In the event that FIRPTA is not applicable to the current owners but could be an issue for the purchasers, a valuation analysis is conducted to determine if the company is a USRPHC at the time of the acquisition, and the test must be conducted regularly on a go-forward basis to determine if at any point the company is deemed to be a USRPHC.

A myriad number of issues can arise as part of a FIRPTA valuation analysis. Working closely with the transaction team (especially the tax advisors), mapping out a pragmatic approach, understanding the drivers of the business, being fully cognizant of any past transactions and/or valuations regarding the company, assessing factors affecting values at each valuation date, and preparing a well-documented report will provide an efficient engagement process and supportable valuation analysis.

^{1 A USRPI is defined as an interest in real property located in the United States or the Virgin Islands, according to Internal Revenue Code (IRC) Section 897(c)(1) and Treasury Regulation (Reg.) Section 1.897-1. Real property as defined for the purpose of being a USRPI includes the following categories:}

1. ^{Land and natural products of the land;}
2. ^{Improvements; and}
3. ^{Personal property associated with the use of real property.}

^{IRC Section 897(c)(6) further defines interest in real property to include fee ownership and co-ownership of land or improvements thereon, leaseholds of land or improvements thereon, options to acquire land or improvements thereon, and options to acquire leaseholds of land or improvements thereon.}

^{© Copyright 2024. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.}