Trends in real estate private equity

Tax design and structuring issues for cross-border investment

  • Share

In the past five years, tax planning and compliance have become a growing concern for real estate private equity funds. In part, as funds become more institutionalized, more and more of their investor base is demanding it, but jurisdictional changes are also having an impact.

Heavy lobbying efforts are underway in the US to encourage more foreign investment in real estate by urging legislators to scale back offshore investors’ tax burden upon exiting a real estate entity.

New developments in Europe

As capital moves between jurisdictions and cross-border investment leads to taxation of the offshore investor, the way it does in the US and could more often in parts of Europe, careful tax planning gains greater significance.

One of the key places to watch will be Germany, which in April signed a new double-taxation treaty with Luxembourg affecting how Luxembourg-based private equity funds are taxed on German investments.

US tax environment

Compared with the US, however, Europe still remains a more friendly tax environment to foreign investors interested in the real estate markets because, unlike the US, it does not enforce special taxation rules on real estate holding companies.

Heavy lobbying efforts are underway in the US to encourage more foreign investment in real estate by urging legislators to scale back offshore investors’ tax burden upon exiting a real estate entity.

At the same time, today’s environment still requires careful planning for offshore investors to meet tax requirements while continuing to maximize their capital gains. (The one exception is sovereign wealth funds, which are permitted special exemptions.)

Precautionary measures

A more widespread issue for funds’ tax planning is the increasing frequency of auditing across many jurisdictions, particularly those facing financial pressure. This trend could ultimately affect how deals are structured among other things.

Whereas tax authorities are very familiar with the common deal structures conceived five to six years ago, they did not pursue auditing as aggressively before the financial crisis. Now, although deal structures have not yet changed radically, fund managers are more aware of the particulars tax authorities are likely to scrutinize and are becoming more focused on day-to-day compliance.

Market risks versus tax risks

In general, while there are a number of economic factors influencing where and how investors place capital, tax practices do not heavily influence them.

Whereas real estate investment in the emerging markets and in southern and central European markets accelerated considerably in the run-up to the financial crisis, investment streams now favor traditionally conservative markets, such as the US and northern Europe, because of investor concerns over market risks, not tax revenue.

Although these markets may require more intense tax planning, investors are comfortable with the relative stability of the property markets in New York, London and Paris, for example, and feel confident about how they underwrite their exit strategies there.