FIRPTA for RICs and REITs – Final Regulations Incorporate Important Changes to Proposed Regulations

On April 24, 2024, the Treasury Department released final regulations under Section 897 of the Internal Revenue Code, a statute commonly known as “FIRPTA” that relates to the ownership and disposition of interests in US real property by foreign persons. Generally, under FIRPTA, a foreign person is subject to US federal income tax on any gain realized on the disposition of US real property and stock of domestic “United States real property holding corporations.”¹ However, special rules apply to qualified investment entities or “QIEs” (including REITs and RICs); namely, FIRPTA tax does not apply to sales by a foreign person of an interest in a QIE that is “domestically controlled” (i.e., generally a QIE, less than 50% of the value of whose interests are owned, directly or indirectly, by foreign persons during the applicable testing period). The final regulations, which primarily address how to determine how indirect ownership affects whether a QIE is domestically controlled, largely adopt earlier proposed regulations, with several key exceptions, including those discussed below. Our prior client alert discussed the proposed regulations in more detail.

Look-through Persons

The proposed regulations applied a look-through rule to certain direct or indirect holders of QIE interests that are defined as “look-through persons” for purposes of determining whether the QIE is domestically controlled. If an interest in a QIE is owned by a look-through person, it is the look-through person’s owners that are relevant for determining whether the QIE is domestically controlled. The final regulations incorporate the proposed regulations’ rules for determining look-through persons, with a few modifications, including the following:

• A non-public (i.e., privately held) domestic C-corporation was considered a look-through person under the proposed regulations if foreign persons hold directly or indirectly less than 25% of the fair market value of its stock. The final regulations incorporate this provision but increase the foreign ownership threshold to 50%, thereby easing the burden of QIEs to determine their indirect ownership through domestic corporations.
• QIEs that are traded on an established US securities market are permitted to assume that a person holding less than 5% of the QIE’s stock is both a US person and a non-look-through person unless the QIE has “actual knowledge” to the contrary. The final regulations retain this safe harbor but specify that actual knowledge includes knowledge that a non-public domestic C corporation is itself foreign controlled as described in the previous bullet.

Transition Rule

The final regulations helpfully add a transition rule that exempts existing QIEs from being required to treat domestic C-corporations as look-through persons until April 24, 2034 (i.e., 10 years from the promulgation of the final regulations) for so long as the QIE does not (i) acquire a significant amount of new USRPIs or (ii) undergo a significant change in ownership. A QIE will be considered to have acquired a significant amount of new USRPIs if the fair market value of USRPIs it acquires, directly and indirectly, exceeds 20% of the fair market value of USRPIs so held as of April 25, 2024. A significant change in ownership occurs when non-look-through persons (applying the final regulations with respect to domestic C corporations) have increased their ownership by more than 50% relative to the QIE stock owned by non-look-through persons on April 25, 2024.

For so long as they are eligible for the transition rule, QIEs in existence as of the promulgation of the final regulations will not need to apply the domestic corporation look-through rules and will be permitted to treat all domestic corporations that hold their stock as US persons for purposes of determining whether they are domestically controlled. After the date within the 10-year transition period that a QIE fails either of the above tests, the QIE will be subject to the final regulations generally in the same manner as any other QIE.

As noted above, the foregoing is a summary of just some of the key provisions from the final regulations; other provisions may be relevant to you as well. O’Melveny will be closely monitoring further developments in this area and can assist clients with analyzing and complying with the final regulations and any future guidance related to FIRPTA and US real property investors. Please contact the attorneys listed on this Client Alert or your O’Melveny counsel for questions regarding the information discussed herein.

¹ A corporation is generally a USRPHC if the fair market value of its interests in US real estate or stock in other USRPHCs is equal to 50% or more of the sum of the fair market value of such assets, the corporation’s interests in foreign real property, and any other assets used in a trade or business.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Billy Abbott, an O’Melveny partner licensed to practice law in California and New York; Alexander Anderson, an O’Melveny partner licensed to practice law in New York; Will Becker, an O’Melveny partner licensed to practice law in Texas; Jan Birtwell, an O’Melveny partner licensed to practice law in England and Wales; and Luc Moritz, an O’Melveny partner licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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