Tier One: Blocking FIRPTA and ECI - How PPVAs Are Reshaping Foreign Investment in U.S. Real Estate

Foreign investors love U.S. real estate for the same reasons domestic investors do: depth of market, rule of law, institutional managers, and an almost endless supply of projects and strategies. The friction point is rarely the investment thesis. It is almost always the tax plumbing, particularly FIRPTA (Foreign Investment in Real Property Tax Act) and ECI (effectively connected income) taxation.

If a foreign investor invests in a structure that is treated as owning a U.S. real property interest, FIRPTA can trigger a withholding regime on disposition (often experienced as a deal-time haircut). FIRPTA withholding is generally 15% of the gross amount realized on a sale of U.S. real property by a foreign person, subject to exceptions and reduction mechanisms. And if the investment is characterized as engaging in a U.S. trade or business or the partnership allocates ECI, ECI withholding can apply at the foreign partner’s highest marginal rate - 37% for non-corporate foreign partners and 21% for corporate foreign partners, under IRC §1446(a).

For many foreign families, pensions, and institutions, the “traditional” response has been some form of blocker corporation, an offshore blocker, U.S. blocker, or a leveraged blocker. These structures can work, but they are often costly, administratively heavy, and can still leak tax in ways that surprise investors once all layers are modeled.

This is where private placement variable annuities (PPVAs) may fit. When used properly, with the right legal, tax, and insurance architecture, PPVAs can be compelling, particularly for sovereign wealth funds and other sophisticated foreign allocators.

Change what the Investor Owns

A PPVA is not a fund. It is an insurance contract. The foreign investor owns an annuity contract and allocates premium to approved investment options, often structured as an insurance-dedicated fund (IDF) or a discretionary managed account inside the insurer’s segregated account.

Under state insurance law and under long-standing federal tax principles, the insurer, and not the policyholder, owns the segregated account assets. That ownership distinction is the entire ballgame for inbound structuring.

Instead of a foreign person or entity being treated as holding a partnership interest with K-1s, ECI allocations, and §1446 withholding, the insurer is the legal owner and taxpayer with respect to the underlying assets. In the FIRPTA context, instead of the foreign investor being treated as holding a U.S. real property interest, the investor is positioned as holding an annuity contract while the insurer holds the investments.

Why Sovereign Wealth Funds Care

Sovereign investors often rely on IRC §892, which can exempt certain income of foreign governments from U.S. tax. But §892 does not exempt income from commercial activities and it does not generally help when the investment is treated as a U.S. real property interest generating FIRPTA exposure.

The PPVA planning thesis many sovereign allocators focus on is that Treasury regulations treat “other domestic securities” as eligible for §892 purposes, and “annuity contracts” fall into that category, supporting the idea that the sovereign’s economic exposure can be routed through an annuity wrapper rather than direct ownership of the underlying ECI/FIRPTA-generating asset.

Stated plainly: the PPVA is used as a re-characterization and ownership interposition tool that can be cleaner than a corporate blocker and materially simpler and cheaper than leveraged structures when implemented within well-defined guardrails.

Treaty (and non-Treaty) Implications: Why “Annuity” Status Matters

Foreign investors worry about two things: (1) tax and withholding, and (2) U.S. filing obligations and IRS “touch points.”

On the withholding side, the default rule for certain U.S.-source fixed or determinable income paid to nonresident aliens is a 30% withholding regime under IRC §871(a) (subject to exceptions and treaty overrides). The reason PPVAs appear in inbound structuring conversations is that, under many U.S. income tax treaties, annuity payments are either exempt from U.S. withholding or taxed only in the investor’s home jurisdiction (often under “pensions and annuities” articles).

Even where a treaty is not available, practitioners sometimes structure PPVAs through a non-U.S. insurer (often with careful attention to whether the carrier has made a §953(d) election to be treated as a domestic corporation for U.S. tax purposes). The 953(d) election framework is well-established in U.S. tax law for foreign insurers and is frequently discussed in cross-border insurance planning.  However, a non-953(d) insurer may be advantageous over an insurer that has made a 953(d) election to be taxed as a U.S. taxpayer.

“Why not just use a blocker corporation?”

Blockers solve some problems, but they introduce others:

• Tax leakage: a U.S. blocker can pay federal and state corporate tax before cash is repatriated, and dividend withholding may follow.

• Complexity and cost: leveraged blockers require careful design, ongoing compliance, and can run afoul of interest limitation and capitalization rules.

• Operational friction: multiple entities, multiple returns, and more friction in underwriting, KYC, and governance.

  
  

By contrast, a well-built institutional PPVA platform can be open architecture, accept IDFs/SMAs, and centralize reporting at the insurer level while shifting the investor’s posture away from “foreign partner in a U.S. partnership” and toward “owner of an annuity contract.”

Diversification and Investor Control

PPVAs are not “magic.” Their utility is tied to strict compliance with two concepts referenced and that experienced practitioners treat as non-negotiable:

1. Diversification (IRC §817(h)): the segregated account must meet statutory diversification thresholds. This has real design implications for single-asset real estate deals.

2. Investor control doctrine: the policyholder cannot be in a position that looks like direct ownership or day-to-day control of the underlying assets.

   
   

In practice, these requirements drive fund design such as IDF structure, manager discretion, rebalancing governance, contract language, and operational procedures. If you get these wrong, you risk collapsing the intended tax treatment.

Q&A

Q: What problem is a PPVA trying to solve for foreign investors in U.S. real estate?

A: Primarily FIRPTA withholding on disposition of U.S. real property interests and ECI/§1446 withholding (plus the tax return/K-1 burden that foreign investors generally want to avoid).

Q: Why is it attractive to sovereign wealth funds?

A: Because §892 planning can be more coherent when the investor is holding an annuity contract (a category referenced in the regulations as a type of “domestic security”), rather than a direct interest in an operating or real estate structure.

Q: Is a PPVA “better” than a blocker?

A: Not universally. But for certain investors, especially those sensitive to tax leakage, filing exposure, and complexity, the PPVA can be an elegant alternative when the investment platform and compliance framework are properly built.

Q: What are the biggest implementation risks?

A: Failing diversification requirements, violating investor control constraints, choosing the wrong carrier profile (including 953(d) posture), and using investment options that are not properly insurance-dedicated.

A Solution for Tax Efficiency

Inbound structuring is ultimately a trade-off between tax efficiency, administrative friction, and technical risk. The reason PPVAs have become a favored tool in certain institutional channels, particularly among sovereign allocators, is that they can convert an otherwise messy U.S. tax profile into a more streamlined insurance-contract posture, while reducing withholding and filing friction that foreign capital typically wants to avoid.

As always, these structures are highly fact-dependent and must be designed with U.S. tax counsel and experienced insurance-dedicated investment platform partners.

At Life Insurance Strategies Group, LLC, we do not sell products.  We help our affluent individual and institutional clients make decisions involving complex life insurance matters.  If we can be of assistance to you, reach out to us via www.lifeinsurancestrategiesgroup.com.