TAXATION OF CUBAN CONFISCATED ASSETS AFTER RESTITUTION***
The Castro regime’s confiscation
was the largest seizure of U.S. property in history, greater than the value
of American assets taken by all other Communist governments combined.(1)
Expropriated U.S. assets included 90% of all electricity generated in Cuba,
the entire telephone system, most of the mining industry, and between 1.5
and 2 million acres of land.(2) Promised compensation for the properties
never materialized. As a result, a number of U.S. corporate and individual
taxpayers took deductions for these losses on their income tax returns.
Claims for confiscated assets remain one of the most contentious issues between the U.S. and Cuba, and appropriate restitution is a statutory condition for normalizing relations with a post-Castro Cuban government. Normalization of relations is inevitable, and U.S. claimants will receive settlements in the form of recovery of their properties or compensation. The tax implications of such settlements are substantial, as estimates of the total present value of U.S. certified claims, including 46 years of accumulated interest, range from $6 to $20 billion.(3)
A major issue is how the IRS will treat U.S. taxpayers who recover properties or receive compensation for confiscated Cuban assets. This is complicated by the fact that many of the one million Cuban exiles and their legal heirs who are now U.S. taxpayers did not file claims or take deductions for confiscated properties, yet will presumably have their assets restored or receive various forms of compensation. While taxpayers who recoup their properties will probably not be subject to taxation except for the amount taken as a deduction for losses, such claimants may be a minority. The majority may receive other forms of compensation that will be subject to U.S. taxation.
During the process of normalizing U.S.-Cuba relations, taxpayers can expect to receive various forms of settlements for their property claims. Remedies will range from actual restoration of original real estate and personal property, substitution for another property of equal value, vouchers redeemable for substitution, future cash payments, shares in joint ventures, privatized companies or investment funds, bonds, or other debt instruments.
The Tax Code treats the return or recovery of property that was once the subject of a deduction as income in the year of its recovery. When an original property is restored to the taxpayer or his heirs, no taxable event has occurred if no deduction was taken for the loss or any deductions taken were not fully used. Taxpayers who took loss deductions on recouped Cuban properties would therefore be liable only for the amount of deductions; they would not owe any excess on their basis despite the asset’s appreciation in value.
Several issues will make the actual restoration of original properties complicated if not impossible. If the U.S. and Cuba reach a bilateral compensation agreement, certified claimants (who have not already sought a resolution to their property claims independently) will receive payments distributed to them by the U.S. government. At that point, the restoration of their properties is no longer an option because they will have been compensated. In other words, the federal government would make claimants a “take it or leave it” offer of a few cents on the dollar – based on a 1960 valuation – with no other remedy.
From 1959 to 1963, over 85,000 new homes were built on confiscated land in Cuba, and the Urban Reform Law gave renters ownership rights. Cubans who received property titles to confiscated residences will probably retain possession of these properties. A post-Castro regime may also recognize adverse possession for social stability as well as to reduce a deluge of restitution litigation.
Under the Tax Code, if property has been confiscated, no gain shall be recognized if it is converted into property that is similar or related in service or use to the property. Such conversions will probably be recognized as non-taxable exchanges -- an exchange in which a taxpayer is not taxed on any gain and on which any losses cannot be deducted. The tax code considers the basis of property in a nontaxable exchange the same as that of the property transferred. Therefore, if taxpayers have not taken deductions for confiscated Cuban property, they will presumably not be subject to taxation even if the substituted asset is worth substantially more than the basis of the original property in 1960 dollars. However, if the substituted property is sold, the amount over the basis will be included in taxable income of the restituted owner.
Monetary compensation received in lieu of confiscated property would probably be a taxable exchange, which occurs when cash or property (e.g. bonds or shares) is received that is not similar or related in use to the property exchanged. The basis of the property received is usually its Fair Market Value at the time of the exchange. If confiscated property is converted into money or into property not similar or related in use to the converted property, any gain is recognized to the extent that the amount realized upon such conversion exceeds the cost of the other property.
This would impose an inequitable burden on taxpayers if a cost basis dating from 1960 back into the early 20th century is used, as many residences and businesses were acquired decades (and in some cases, centuries) before the 1959 Revolution. This is demonstrated by claims filed by Chase Manhattan Bank. On its books Chase listed its real estate holdings at a depreciated cost of $110,000. The last appraisal of any Chase branches was made in March 1960, and applied only to the Havana office. This valued the premises at $165,000, and the necessary adjustment to bring the book value for that property to market was stated as $54,800. Today this building is worth at least $400,000; within a year after normalization of relations its value will probably double.
The Tax Code allows taxpayers whose property has been converted into money or dissimilar property to avoid taxable gains by (a) purchasing similar property with the proceeds within two years, or (b) purchasing a controlling interest (80% of the combined voting power of all classes of stock and at least 80% of the total number of shares of all other classes of stock) in a corporation owning such other property.(4) It would be unreasonable to expect that most compensated taxpayers would be willing or able to buy similar properties (in the U.S. or Cuba), and it is unlikely that there would be many opportunities for even large U.S. companies to purchase a controlling interest in corporations owning similar Cuban properties within two years after compensation.
Another major issue that will confront taxpayers is how the IRS will value restituted properties or compensation. Even though many industrial assets will have lost their original economic value (e.g. sugar mills built in the 1920s), the discrepancy between book value and FMV after nearly half a century will be enormous in most cases. For example, in 1994, the Mexican firm Grupo Domos purchased 49 percent of EmtelCuba for $1.5 billion which represented half of Cuba’s generally antiquated telephone system.(5) In comparison, in 1960 ITT was allowed a claim of $130.7 million for Cuba’s entire telephone system. The Helms-Burton legislation contemplates that, with limited exceptions, U.S. courts will adopt the valuations determined in awards issued by the Cuban Claims Program. In cases where a plaintiff was not eligible to file a claim (i.e. was not a U.S. national at the time of confiscation), the legislation authorized U.S. District Courts to appoint the Foreign Claims Settlement Commission as Special Master to make determinations on such issues as ownership of property, for use in court actions.(6)
Applying half-century-old valuations to properties in a market that will probably grow as fast as that of the East Berlin real estate sector in the post-Communist era would be unrealistic and unfair to claimants.(7) For example, in Havana’s upscale Miramar district, where many Cuban exiles lived, a 31-apartment complex built in the late 1990s sold out in weeks to foreign buyers at prices ranging from $94,000 for a studio to $400,000 for a penthouse.
Another issue is how the IRS will treat successors in interest. Since the 1960s, a significant number of the 78 publicly owned U.S. corporations that suffered asset seizures in Cuba have been merged, acquired or dissolved. Generally, the corporation surviving a statutory merger assumes all the powers, rights, debts, and liabilities of the corporation merged into it.
An example of the accounting and legal complexities that will be involved in Cuban settlements is the case of Moa Bay Mining Company, which claimed $88.3 million in confiscation losses. The company was wholly owned by Freeport Nickel Company, a subsidiary of Freeport Sulphur Corporation. Today Freeport is owned by a joint venture between IMC Global Inc. – the world’s largest purchaser and user of sulphur – and Savage Industries Inc., a major materials management and transportation systems company. The possible compensation for Moa Bay’s Cuban assets should be of interest to IMC and Savage, as the current value of its confiscated nickel and cobalt mining assets is estimated at $5-7 billion.
Some taxpayers may choose to relinquish their property claims rights or give them to relatives or friends because they are not interested in their properties or compensation. Taxpayers who relinquish claims may nonetheless be liable for taxation. Generally, the IRS position is that assigned claims or property fall under the “assignment of income” doctrine, under which the taxpayer cannot avoid recognizing income by assigning it to another person, unless his renunciation of the property amounts to an abandonment of his rights without a transfer of rights to another.
Taxpayers who give claims rights to friends or relatives as gifts are subject to gift tax on the transfer, with the statutory annual exclusion. The value of the gift is excluded from the recipient’s gross income, regardless of the amount of the gift. Relinquishing the right to the property/compensation may be interpreted as a gift to the Government of Cuba.
U.S. taxpayers (including Cuban exiles) whose properties were taken by the Castro regime may suffer additional victimization if they receive compensation at present value, which in most cases would be a large multiple of their basis in the property. Many such claimants would be unable to pay income tax on compensation received for properties that may now be worth millions of dollars. For example, last year a 95-year-old woman filed an action in federal court against the Club Med hotel chain for building a luxury resort on Varadero beachfront property confiscated from her family, which also owned prime real estate occupied by two other foreign hotels chains.
One solution may be for the U.S. Congress to enact legislation to allow qualifying taxpayers to exclude compensation payments from taxable income. A precedent is the 2001 Economic Growth and Tax Relief Reconciliation Act which allowed Holocaust survivors, their heirs or estates to receive the full benefit of any compensation payment made by governments or industry by excluding from income taxes compensation payments. Cuban exiles (and U.S. nationals) were similarly victims of tyranny and should not be unfairly burdened by being taxed on compensation if their actual properties cannot be restored.
Another argument is that it would be discriminatory to allow taxpayers (who did not take a tax deduction) to receive restituted or substitute properties tax-free, whereas those who receive monetary compensation that exceeds the original basis of the property (which may happen in most cases), will have the excess taxed as ordinary or capital gains. This would be contrary to the doctrine of horizontal tax equity, under which taxpayers in similar circumstances should be taxed in similar ways. This doctrine has a constitutional foundation; under the equal protection clause, tax legislation enjoys the greatest degree of freedom to classify.
When the normalization of U.S.-Cuba relations commences, the IRS will be confronted with unprecedented tax issues. In addition to Fortune 1000 companies, as many as one million Cuban-American taxpayers may have property claims against assets valued in tens of billions of dollars. Because of the unique circumstances involving politics, history and geography, the U.S. government will need to address these special tax circumstances in ways that redress past injustices and encourage positive economic, political, and social changes in Cuba.
(1) Statement of Senator Richard Stone (D-FL), Outstanding Claims Against Cuba, Hearings Before Subcommittees on International Economic Policy & Trade, and on Inter-American Affairs, Committee on Foreign Affairs, House of Representatives, 96th Cong., Sept. 25, 1979, at 6 (1980).
(2) For example, North American Sugar Industries owned a tract of land approximately 42 miles by 30 miles (3,300 square kilometers) and three sugar mills, including two of Cuba’s largest.
(3) Joint Corporate Committee on Cuban Claims 2005.
(4) IRC § 1.1033(a)(2)(c).
(5) Ted Bardacke, Mexican firm breaks new ground in Cuban telecom field, DEVELOPMENT BUSINESS, July 31, 1994.
(6) FCSC: 2001 Annual Report, FOREIGN CLAIMS SETTLEMENT COMMISSION OF THE UNITED STATES, U.S. Dept. of Justice (2001).
(7) Like Havana, the demand for housing in Berlin far exceeds the supply. Prices for residential properties in the most desirable parts of the city reach 6-7,000 EUR per sq, meter ($2,575-$3,000 per sq. ft.), and the average in the city is 2,300 EUR per sq. meter ($986 per sq. ft).
*Sr. Research Associate, Institute for Cuban and Cuban-American Studies, University of Miami and Consultant, Duane Morris, LLP.
**Consultant, Mastrapa Consultants.
***This Focus is based entirely on the previously published article co-authored by Timothy Ashby and Tania Mastrapa, "Taxation of Cuban Confiscated Assets After Property Claims Settlements: Issues for Taxpayers and the US Government," International Law Quarterly 21, no. 1 (Summer 2005):5-11