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  • Writer's pictureJay Judas

Tier One: PPVA - Generating Tax Efficiency for Tax Exempt Institutions and Foreign Investors

Whenever I mention that tax exempt organizations such as foundations, endowments, charities and pensions are subject to taxation, I find many people to be surprised. After all, the term ‘tax exempt’ means to be exempt from taxation so finding out this is not the case, is perplexing.

The same is true of foreigners who invest into U.S. real estate. These buyers are not U.S. citizens or residents, so how could this be true?

The Problem

Specifically, tax exempt organizations are subject to unrelated business taxable income (“UBTI”) on investments that are unrelated to their primary purpose. IRC §512(a) defines UBTI as gross income (less directly connected expenses) derived from an “unrelated trade or business.” Tax rates can exceed 21%.

This means, for example, that the endowment of your university faces UBTI when it invests into sectors like commercial real estate, lending, life settlements and many other alternative investments.

Similarly, foreign investors are generally taxed on investment income from a U.S. trade or business considered to be Effectively Connected Income (“ECI”). ECI is often generated from the same sectors mentioned that generate UBTI for tax-exempts.

Then, in addition to ECI taxation, under the Foreign Investment in Real Property Act of 1980 (“FIRPTA”), these foreign investors are also subject to taxes on gains on the sale of U.S. real property interests. Combined tax rates for ECI and FIRPTA can exceed 40%!

Old School Solutions

Traditionally, tax exempt organizations and foreign investors have addressed their requisite taxation by:

  • Forgoing investment or accepting a minor amount of UBTI, FIRPTA and/or ECI;

  • Establishing and utilizing a complex blocking and feeding structure; or,

  • Applying debt or options.

Forgoing an attractive investment, usually an alternative investment, because of UBIT, ECI and/or FIRPTA is frustrating to many managers. However, if the investment is not made, there’s no taxation – not a very innovative solution.

By setting up a blocking entity - usually a corporation set-up in an offshore jurisdiction - all taxation discussed can be blocked. The downside to this strategy is that this structure is expensive to establish and an administrative headache (I’ve heard ‘nightmare’ used). Also, public perception of the use of offshore entities to lower taxes is increasingly negative, so public-linked tax exempts, like state university endowments or pensions, often avoid establishing offshore blocking companies.

The use of debt or options is somewhat popular, especially with real estate where leverage is often employed. This strategy can create some tax-efficiency but, due to the limits on interest deductibility, usually does not come close to addressing the tax burden from UBTI, ECI and/or FIRPA.

PPVA to the Rescue!

The solution for these investors is to the make the investment through a private placement variable annuity (“PPVA”).

PPVA contracts generate annuity income, which is excluded from the definition of UBTI, FIRPTA and ECI. If the investments are held within a PPVA contract, the income is not characterized as UBTI, FIRPTA or ECI because the insurance company is treated as the legal owner (“separately held”) of the investment rather than the PPVA holder, converting the UBTI income into annuity income.

A tax-exempt or foreign investor owner receives the economic benefits of the underlying fund’s investment performance through annuity distributions. Unlike other structures, the PPVA does not have any tax burden. Under §72(u)(1), when an annuity is held by a non-natural person, the annuity loses its ability to defer ordinary income taxation on any growth in the annuity’s underlying account value. As a result, a tax-exempt owner of a PPVA issued from a domestic or §953(d) issuer would be taxed at its 0% tax rate on ordinary income, which is considered ordinary income.

A foreign investor owner of a PPVA issued from a foreign non-§953(d) insurer would be taxed at its 0% tax rate, assuming the insurer is able to take a corresponding tax deduction. If a domestic or §953(d) issued PPVA is used, FIRPTA and ECI taxation is blocked for the foreign investor; however, the investor could be subject to a much smaller taxation on the gain from annuity distributions as stated in any applicable tax treaty between the U.S. and investor’s country.

The additional benefits of using a PPVA to make these investments are significant. The cost of the PPVA is low and significantly less than the cost of blocker entities. A PPVA permits investments without the need to file Form 990T or to complete K-1 forms. Plus, a private placement life insurance company’s open architecture permits the on-boarding of applicable investments and outside investment managers. This isn’t found with traditional retail insurers.

Working with LISG

We regularly work with investment managers in helping them understand and establish the framework for using PPVAs as an offering to their tax-exempt and foreign clients. At LISG, we do not sell products and can therefore offer independent and unbiased advice when it comes to sourcing life insurance solutions for complex transactions. If we can help you or your firm, reach out to us today at


The Law


  • U.S. tax-exempt investors are taxable on their UBTI under IRC Section 512-514.

    • Income is from a trade or business.

    • The business is carried on directly or indirectly through a pass-through entity, e.g., a limited partnership or limited liability company.

    • Business is not related to an exempt function (e.g., sale of admission tickets by an art museum).

    • The rule generally applies to direct investments in commercial activities, master limited partnerships, mineral exploration, active securities trading, etc. The rule does not apply where the activity is carried on by a “C” corporation of which the tax-exempt entity is a shareholder.

    • Investment income, including from rents, capital gains, annuities, and royalties are excluded from trade or business income. (See Reg. § 1.512(b)-1(a).)

  • Similar rules apply to a tax-exempt’s un-related debt financed income. (See IRC Section 513.)

  • IRC §72(U) states an annuity held by a person who is not a natural person shall not be treated as an annuity contract (other than under subchapter L), and the incomes on the contract shall be treated as ordinary income received or accrued by the Owner.

  • Subchapter L relates to the taxation of life insurance companies and permits an annuity owned by a non-natural person to retain its treatment as an annuity contract. See PLRs 200449017 & 9708022.

  • Therefore, since the annuity owned by a non-natural person complying with Subchapter L is still defined as an annuity, any UBTI-generated income within the annuity is re-characterized as ordinary income.

  • The characterization of the income within the annuity owned by a non-natural person is deemed ordinary income and taxed at ordinary income rates.

  • In addition, distributions from an annuity owned by a non-natural person are also deemed ordinary income and taxed at ordinary income rates.

  • The ordinary income tax rate for applicable tax-exempts is 0%.


  • IRC Section 897(a) (FIRPTA) subjects gains of a foreign person on the sale of U.S. real property interests to taxation.

    • Interest in U.S. real property consists of “any interest, other than an interest as a creditor…in real property located in the United States” and certain shares of a U.S. Corporation owning U.S. real estate.

    • An interest in US real property includes “any direct or indirect right to share in the appreciation in the value, or in the gross or net proceeds or profits generated by the real property.” Reg. §1.897-1(d)(2).

    • Domestically controlled REITS and publicly traded corporations are excluded.

    • Withholding applies on the sale of U.S. real property interests.


Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at


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