Understanding the Implications of Section 897 Final Regulations in International Taxation

On April 24, 2024, the U.S. Treasury and the IRS released final regulations (TD 9992) under Section 897, the Foreign Investment in Real Property Tax Act (FIRPTA). TD9992, among other things, addresses domestically controlled qualified investment entities (QIEs). A QIE is defined as either a real estate investment trust (REIT) or certain regulated investment companies (RICs) that primarily hold U.S. real property. The Final Regulations adopt the proposed regulations published on December 29, 2022, with a few modifications to the Section 892 exemption and some additional rules.

The Final Regulations relate to foreign persons who own stock in a foreign-controlled QIE that is also a U.S. real property interest (USRPI). USRPI is broadly defined and includes interests in any domestic corporation unless the taxpayer establishes that such corporation was at no time a U.S. real property holding company during the five-year period that ends on the date of the disposition or the holding period of the taxpayer, if shorter. Section 897(h)(2) also provides that an interest in a domestically controlled QIE is not a USRPI; therefore, the gain realized by a foreign person on the disposition of a domestically controlled QIE is excluded from taxation under FIRPTA.

A QIE is domestically controlled if, during the entirety of the five-year period ending on the date of the relevant disposition, less than 50% of the value of the shares is held directly or indirectly by foreign persons. For purposes of determining the direct and indirect holders of QIE stock, the Final Regulations divide taxpayers into “look-through persons” and “non-look-through persons.” Non-look-through persons include individuals, foreign corporations, tax-exempts, publicly traded partnerships, public RICs, etc. They are viewed as holders of the QIE stock. Look-through persons include non-publicly traded partnerships, trusts, S corporations, RICs, non-publicly traded REITs, etc.

A domestic corporation is a non-look-through person if it is not foreign-controlled. This is defined as having more than 50% (as opposed to 25% in the proposed regulations) of the fair market value of its stock held directly or indirectly by a foreign person. The shareholders, partners, or beneficiaries of the look-through persons are viewed as holders of the QIE stock.

The final regulations took effect on April 25, 2024, and include transition rules that exempt existing structures from the final domestic corporation look-through rule for a ten-year period, with certain requirements.

Contact our Global Business Services team for more information on Section 987 Final Regulations or any other international tax issue.