Will Pillar Two Block Multinationals’ Real Estate

Section 1031 of the US tax code and the rollover provisions of foreign corporate income tax laws have been used by large US-based multinationals to defer tax on the sale of real estate whose proceeds are reinvested in other real estate. For example, in 2013, Hyatt Hotels Inc. acquired the Hyatt Regency Orlando in a Section 1031 exchange valued at $717 million. Likewise, foreign-based multinationals have used Section 1031 to defer tax on their US subsidiaries’ exchanges of US real estate.

Pillar Two

The proposed OECD Pillar Two regime can impose a special tax in some cases where a covered multinational’s corporate group, either in the US or a foreign country, has less than a 15% effective tax rate (ETR) on its overall financial accounting income. Pillar Two applies this tax through various rules, such as a qualified domestic minimum tax (QDMT) rule, an income inclusion rule (IIR), and an undertaxed profits rule (UTPR).

There is considerable uncertainty as to whether, when, and how the US and foreign countries will implement and interpret Pillar Two. Thus, it is not possible to predict with certainty the interaction of OECD Pillar Two with current and future US tax laws in general and the interaction with Section 1031 transactions in particular.

In addition, the Biden administration has proposed generally repealing Section 1031, independent of its positions on Pillar Two. The Build Back Better Act proposed instituting a corporate minimum tax on very large corporate groups based on pre-federal-tax financial accounting income. Such proposals could even more directly affect Section 1031. The discussion below focuses on the possible application of Pillar Two tax by the US on foreign subsidiary income from a foreign rollover and the possible application of Pillar Two tax by foreign governments on US subsidiary Section 1031 transactions. It assumes, for example, that Section 1031 is not repealed and the proposed US minimum tax on financial accounting income is not enacted.

With respect to the possible application of Pillar Two tax by the US on foreign subsidiary income, one might expect that the US may adopt a revised, 15% or higher rate, per-country GILTI, as proposed in the Build Back Better Act. If so, some commentators believe such revised GILTI would be accepted by other countries as meeting the Pillar Two criteria for a qualified IIR. The favorable consequence of such qualified IIR characterization of GILTI would be that the UTPR would then not apply to tax income of low-taxed foreign subsidiaries of US-based multinationals.

However, Pillar Two generally contemplates reliance on financial accounting. PLR 201027036 and Treas. Reg.Section 1.951A-2(c)(2)(i) indicate that a foreign subsidiary’s GILTI excludes its gain on a foreign-to-foreign real estate exchange structured to qualify for nonrecognition under the Section 1031 rules, even where the subsidiary recognizes gain under GAAP. But GILTI, unlike the Pillar Two rules, does not favorably take into account any financial accounting deferred foreign tax liability associated with foreign rollovers.

Effective Tax Rate

The rules of Pillar Two generally only impose a tax where a covered multinational’s corporate group, in the US or in any foreign country, has less than a 15% ETR. The ETR is generally determined by dividing the numerator of income tax expense in that jurisdiction, as determined for the parent’s financial accounting purposes and with certain adjustments, by the denominator of financial accounting income in that jurisdiction, also with certain adjustments. The ETR is computed on a jurisdiction-by-jurisdiction basis and not on a transaction-by-transaction basis. The financial income tax expense for the year of sale includes both the current financial accounting income tax expense and the financial statement deferred tax liability.

Adversely for purposes of the year-of-disposition ETR calculation, the financial accounting current income tax expense that is triggered by a no-boot Section 1031 exchange or a complete foreign rollover is zero. Favorably for purposes of the year-of-disposition ETR calculation, the financial statement deferred income tax liability—such as that triggered on a Section 1031 exchange or foreign rollover—is considered by Pillar Two, at least to some extent.

Under a special rule, this deferred tax liability, for purposes of the ETR calculation, is measured at the lower of 15% or the jurisdiction’s general tax rate. As applied to higher corporate tax rate countries like the US, this 15% cap is favorably set high enough that a Section 1031 exchange or rollover itself, on which financial accounting deferred taxes were applied to the gain, will not create a marginal Pillar Two tax. The 15% is set low enough to prevent the Section 1031 exchange or rollover from triggering an immediate deferred tax liability that can be taken into account to increase an ETR that is otherwise less than 15% due to other transactions.

The deferred tax liability, also computed at the 15% rate, on the Section 1031 exchange or same-foreign-country rollover exchange, as it is subsequently reversed over time to reduce future years’ financial accounting income tax expense, adversely reduces the numerator of the 15% ETR testing fraction in future years. While Pillar Two generally requires that deferred tax liabilities from timing differences that do not reverse within five years be retroactively recaptured to reduce financial accounting tax expense in the year they were created, US Section 1031 and same-country foreign real estate rollovers are favorably excepted by Pillar Two from this recapture rule. If the corporate tax rate in a rollover foreign jurisdiction is less than 15%, however, then a Pillar Two tax liability may arise for that jurisdiction on account of the rollover.

The administration’s FYE 2023 budget message proposed that the US could potentially impose a Pillar Two tax on US subsidiaries of large foreign-based multinationals if they have low-taxed foreign group members by applying UTPR rules. Similarly, it proposed that the US can impose a QDMT on a US parent group itself if the US parent group’s ETR is less than 15%. However, while far from clear, some commentators interpret the FYE 2023 budget message as permitting financial accounting deferred income tax liabilities to be favorably considered along the lines of the Pillar Two rules.

Pillar Two Tax

When a jurisdiction’s ETR is less than 15%, that jurisdiction’s Pillar Two tax base is generally financial accounting income, less a percentage, phasing down to 5%, of the payroll and average business real estate and certain other assets located in that country. When the excess of 15% over the jurisdiction’s corporate tax rate is applied to this tax base, if positive, the resulting product is the Pillar Two tax. If this Pillar Two tax is not collected by a QDMT, the IIR or UTPR will apply.


Section 1031 exchanges of a US corporate group—and the foreign rollovers of a foreign country corporate group—will likely favorably not generate any immediate marginal tax under Pillar Two if subject to a deferred financial accounting foreign corporate tax liability provision rate of at least 15%. However, under Pillar Two, foreign rollovers of a foreign country corporate group where the rate is below 15% may generate an immediate marginal tax.

With respect to rolled-over gain, the highest corporate tax rate countries will in the long term generally trigger the highest corporate income tax cost. In the short term, it generally would be replacement transactions in the zero general corporate rate tax-havens due to Pillar Two tax, with their absence of both current and deferred financial accounting tax expense. This could generate the highest immediate tax cost. For a tax-haven subsidiary of a US-based multinational, if the US GILTI regime is continued and accepted as a Pillar Two qualified IIR, Pillar Two would not impose the UTPR then even if there is no QDMT. As a consequence, under PLR 201027036, even tax-haven foreign subsidiaries of US parent corporations could avoid Pillar Two tax on their foreign real estate exchanges if these exchanges are structured to qualify under the Section 1031 rules.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.

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