Moira Dickinson is a senior writer at SNL Financial. The views and opinions expressed in this piece represent only those of the author and not necessarily those of SNL.

The U.S. commercial real estate industry continues to hunger for capital, but tax legislation currently in place throws up a barrier to one potential source of funds: international investors.

The quest for equity has dominated headlines over the last several years in the wake of the credit crisis. REITs and REOCs have been successful over the last year or so in raising more than $20 billion of equity, allowing them to shore up balance sheets and meet near-term maturities, but more is needed. Michael Kirby, principal with Green Street Advisors, said at a recent conference hosted by NYU that he sees a need for REITs to raise "tens and tens" of billions of dollars of equity to appropriately delever.

The commercial real estate industry as a whole has hundreds of billions of dollars of debt maturing over the next few years. With the steep declines in asset values and lenders employing much-stricter underwriting standards, the industry is facing the need for much more equity. Advocacy group the Real Estate Roundtable reports that preliminary conservative estimates predict that the equity gap will exceed $1 trillion over the next several years.

Foreign capital could be a viable source of much-needed equity. According to a survey conducted by the Association of Foreign Investors in Real Estate, the U.S. is and has for years been perceived as the country providing both the most stable and secure real estate investments and also the best opportunity for capital appreciation. In terms of global cities for real estate investment, only London ranks ahead of Washington, D.C., and New York City.

However, tax laws in the U.S. go far to discourage foreign investors from putting dollars to work in the U.S. The Foreign Investment in Real Property Tax Act — enacted in 1980 to discourage foreign investment in farm land and kept in place as the Japanese and others began buying trophy assets in the U.S. — requires foreign investors to pay U.S. federal income tax on gains recognized upon the disposition or sale of U.S. real property interests, which include sales of interests in parcels of real property as well as sales of shares in certain U.S. corporations that are considered U.S. real property holding corporations. Under the legislation, foreign investors can be required to pay up to roughly 55% in taxes.

Under FIRPTA, REITs that are considered domestically controlled, that is they have less than 50% foreign ownership by value, are not considered USRPI, and foreign investors in those REITs will not be subject to taxation under FIRPTA when they dispose of their stake, according to Deloitte. However, dividend distributions to those investors by the REIT attributable to the REIT's gain from sales or exchanges of USPRI are subject to U.S. tax under the legislation.

Sovereign wealth funds, as defined by the U.S. Treasury Department as government investment vehicles funded by foreign exchange assets that manage those assets separately from the official reserves of the monetary authorities, are exempt from U.S. income tax, according to Deloitte.

"The FIRPTA taxation and compliance rules are unique to U.S. real estate," Willys Schneider, partner with Kaye Scholer LLP, writes in a recent article for an AFIRE publication. "They have a significant impact on just about any real estate related investment. Foreign investors will be well-advised to factor in taxes under FIRPTA in assessing their projected profit on an acquisition."

The Real Estate Roundtable says the "obstacles that are imposed under FIRPTA have led many non-U.S. investors to invest in real estate elsewhere — in countries such as Brazil, China and India — shifting wealth and economic dynamism away from the U.S. market." Further, it contends that FIRPTA taxation is "completely at odds" with the way the U.S. taxes other forms of foreign investment in the U.S.

"With a few technical exceptions, FIRPTA is literally the only major provision of U.S. tax law that subjects non-U.S. investors to taxation on capital gains realized from investment in U.S. assets. By modifying FIRPTA, non-U.S. investors will be encouraged to inject much needed capital into the U.S. real estate markets," the group says.

Borja Sierra, executive managing director with Savills US, explained to SNL on March 22 that the current tax policy favors foreign investors taking a minority position in deals, which triggers problems for those that need to have control of the asset in terms of both economic and voting rights. "So many investors have simply not been investing in the U.S. because they were in a disadvantaged situation when they exited, having to pay FIRPTA," he said. If that barrier is removed, more investors will seek to be in the U.S., Sierra said, adding that the number of foreign investors looking at the U.S. market has been increasing over the last year and a half.

The positive news on that front is that legislation has been introduced that would change some of the FIRPTA provisions and thus make U.S. real estate investment more palatable to foreign investors. The Real Estate Revitalization Act of 2010, H.R. 4539, introduced by Rep. Joseph Crowley on Jan. 27, would, according to a summary of the bill, redefine "United States real property interest" to eliminate exclusions relating to interests in holding corporations; treat distributions of real property interests by a REIT or a regulated investment company as ordinary dividends; and repeal the election allowed to foreign corporations to be treated as a domestic corporation for purposes of investment in a USRPI.

While timing of the bill is uncertain, William Mack, founder and chairman of AREA Property Partners, said at NYU's recent REIT conference that there is a reasonable chance the rules could be changed by the summer (though others reacted with skepticism to that statement).

Kylie Rampa, senior managing director of Macquarie Capital (USA) Inc., said at a recent AFIRE conference in New York City that the legislation could absolutely change how international investors view the U.S. "It's been an enormous barrier," she said. "When you look at returns back into your own currency, into your own home where the capital has come from, the tax leakage through the tax structure has been quite enormous versus other markets." That has made the U.S. very uncompetitive versus other markets from a global perspective.

"I think it would have a meaningful impact on allocations into direct real estate for the U.S., absolutely, from not only Australia but from many of the Asian countries and obviously the European countries," Rampa added.

The U.S. is blessed by the fact that despite all of the current turmoil, it still is viewed as an attractive investment arena by foreign capital. Perhaps now is the time to stop making it more difficult for that capital to actually be deployed and modify, if not repeal, FIRPTA.