Wednesday, April 8, 2009

FIRPTA Foibles Finance From Far East

As of March 16, 2009, the total U.S. federal debt was $11,042,553,971,450.47. A traditional defense of the national debt is that Americans "owe the debt to themselves", but that is becoming increasingly less accurate. The US debt in the hands of foreign governments was 25% of the total in 2007, virtually double the 1988 figure of 13%. Despite the declining willingness of foreign investors to continue investing in US dollar denominated instruments as the US dollar fell in 2007, the U.S. Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public. About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China. In total, lenders from Japan and China held 47% of the foreign-owned debt. And recently, word is spreading that the Chinese have pulled back their investments in US Treasuries.

When it comes to real estate, however, foreign investment is not very common, because it simply isn't very easy.

The Foreign Investment in Real Property Tax Act (FIRPTA) is a statute that requires that a seller, who is a foreign person, permit a withholding of a part of the selling price (generally 10%) against the United States gains taxes that the foreign person will owe on capital gains earned on the sale of real property.

FIRPTA was enacted in 1980. A senator from Michigan was concerned about farm land and wanted to protect “the American heartland” from foreign interests. The world has changed, but FIRPTA has not. Many of the rules that were written in the 1980s look outdated and unsuited to modern investment practices because they were written with a particular paradigm in mind, that being a single foreign investor or a small group of foreign investor acquiring US real property.

Non US investors in US real property are subject to fundamentally different US federal income tax rules than those that apply to their investments in US corporations or other capital assets. Most notably, a foreign person’s gains attributable to the disposition of capital assets other than US real property interests are not subject to US tax. FIRPTA discriminates against the asset class of real property.

To exacerbate this problem, most of the US debt that China and Japan do own is bought by Asian banks, which in China are controlled by the government, and the governments themselves in addition. It is very difficult for wealthy Chinese businessmen to funnel personal money out of China and into the US for personal investment in real estate for this reason in addition to FIRPTA. Yet, there is an increased flavor for it. This is due to the United States general macroeconomic and governmental stability relative to other foreign countries, and the relative weakness of the dollar and the economy. As we all know, the yields, by almost any metric used, in commercial real estate have increased by hundreds of basis points across all sectors in the last year.

If FIRPTA was repealed, not only would this stimulate foreign investment in the US, but it would make it easier for the investment to be private, rather than public investment. Just among domestic ownership of commercial US real estate, the percentage of private ownership is staggeringly high. If we make foreign investment easier, logic would suggest that the ratio would be similar. In an overall foreign investment ratio, foreign real estate investment would help balance public versus private investment. This would provide a good hedge against any sudden and potentially economically catastrophic and ruinous move by the Chinese government to stop investing in the US, or essentially financing our burgeoning debt ratios.

Repealing the outdated FIRPTA law would simply allow us to avoid potential economic disaster, as it spreads risk from one large powerful investor, the Chinese Government, to a lot of individual, and therefore less powerful investors. By allowing this foreign investment, we increase foreign equity in the US, rather than continuously inflating our debt to foreigners. This, in and of itself may provide enough influence to foreign governments to continue financing our debt, because their citizens interests are economically more aligned with US citizens. If Asian Governments decide to pull the proverbial plug, sending our economy into disarray, their own domestic private sector would stand to lose as well.

For those of you who agree with that Michigan Senator from 1980 who helped put FIRPTA into law, I would remind you that the Fart East already owns America anyway. Repealing it is simply a way to make sure foreigners don't really control our fate as a nation by aligning their interests with our own. After all, this isn't 1980, and we do live in a global economy.

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