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IRS Issues Proposed Regulations Impacting the Determination of Domestically Controlled REIT Status

CEO Khai Intela
The Treasury Department and the Internal Revenue Service (IRS) have recently published proposed regulations that could have a significant impact on the interpretation of the definition of "domestically controlled" real estate investment trust (REIT) status....

The Treasury Department and the Internal Revenue Service (IRS) have recently published proposed regulations that could have a significant impact on the interpretation of the definition of "domestically controlled" real estate investment trust (REIT) status. These regulations aim to address the common practice of foreign investors using a foreign-owned domestic corporation to create a domestically controlled REIT.

Understanding the Importance of Domestically Controlled REIT Status

Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), foreign investors are generally subject to taxation on gain or loss from US real property investments. However, there is an exception to this rule when it comes to the sale of stock in a domestically controlled REIT. A domestically controlled REIT is a REIT in which non-US persons hold less than 50 percent of the interests. This exception has been widely used by foreign investors to acquire US real estate and structure their exit strategy to avoid FIRPTA taxes.

Changes Under the Proposed Regulations

The Proposed Regulations introduce a new concept of "look-through persons" and "non-look-through persons" to determine if a REIT is domestically controlled. Look-through persons include regulated investment companies, REITs, S corporations, non-publicly traded partnerships, and trusts. On the other hand, non-look-through persons include individuals, domestic C corporations, nontaxable holders, foreign corporations, publicly traded partnerships, estates, international organizations, qualified foreign pension funds, and entities wholly owned by qualified foreign pension funds.

One significant change is that a non-public domestic C corporation will be treated as a look-through person if it is a foreign-owned domestic corporation. This means that a REIT shareholder that is a private taxable domestic C corporation will be considered a look-through person if 25 percent or more of its outstanding stock is held by foreign shareholders. This change aims to prevent the use of intermediary domestic C corporations to create domestically controlled REITs.

Next Steps and Considerations

While these proposed regulations are not yet final, it's crucial for real estate sponsors, fund managers, and REITs to review their tax structures and fund organizational documents to evaluate the potential impact of these changes. Additionally, it would be advisable for real estate sponsors to request additional information from investors regarding ultimate ownership to determine the status of their domestically controlled REIT structures.

The Treasury Department and the IRS will be soliciting public comments for the next 60 days, during which taxpayers can provide feedback on these proposed regulations. It is expected that taxpayers will request the reconsideration of certain rules in line with prior guidance.

In conclusion, these proposed regulations have the potential to significantly impact the determination of domestically controlled REIT status. It's important for those involved in real estate investments to stay informed and take appropriate steps to navigate these potential changes.

Diagram 3 Diagram 3: Example illustration of the rules under the Proposed Regulations.

Diagram 4 Diagram 4: Example illustration of the rules under the Proposed Regulations.

Diagram 5 Diagram 5: Example illustration of the rules under the Proposed Regulations.

Diagram 6 Diagram 6: Example illustration of the rules under the Proposed Regulations.

Note: All section references are to the Code and the Treasury Regulations thereunder unless otherwise stated.

If you have any questions or would like more information about the impact of the Proposed Regulations, please reach out to any of the following members of the DLA Piper team: Jesse Criz, Allen Ashley, Shiukay Hung, Jeffrey Zanchelli, Emily Snyder, John Sullivan, Barbara Trachtenberg, Rob Bergdolt, Chris Stambaugh, Carrie Hartley, Laura Sirianni, Katie LaKoma, Joshua Lingerfelt, Kentaro Murase, Matthew Hilowitz, and Allan Bowen.

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