- with readers working within the Insurance industries
The Internal Revenue Service issued Proposed Regulations that, if finalized, will eliminate a recently introduced rule for determining whether a REIT is a domestically-controlled REIT (a DC-REIT). Eliminating this rule will allow REITs to continue employing historically accepted share ownership structures designed to cause a REIT to qualify as a DC-REIT.
BACKGROUND
If a taxable U.S. person sells REIT shares, any gain realized from that sale is included in that person's U.S. income. If a foreign person1 sells REIT shares, any gain from that sale is not subject to U.S. tax if the foreign person is selling shares of a domestically controlled REIT (a DC-REIT).
A REIT is a DC-REIT if less than 50% of its stock (by value) is held, directly or indirectly, by foreign persons. If 50% or more of the REIT's shares are held by foreign persons, then the REIT will not be a DC-REIT. If the REIT is not a DC-REIT, then gain realized by a foreign person on selling stock of that REIT will be subject to U.S. tax under FIRPTA. Under FIRPTA, the gain is treated as income that is effectively connected with a U.S. trade or business.
Some foreign investors hold REIT shares through U.S. corporations. In those cases, the U.S. corporation, and not its foreign shareholder(s), was historically treated as holding REIT shares. Since the U.S. corporation is treated as a U.S. person for the DC-REIT ownership test, that corporation's share ownership would be helpful. For this reason, U.S. corporations for foreign REIT shareholders had been a long-standing practice, until April, 2024.
2024 REGULATIONS
In April of 2024, the IRS issued final regulations (the 2024 Regs) that cause some domestic corporations to be treated as "foreign-controlled domestic corporations." A domestic corporation is "foreign-controlled" if more than 50% of the shares of that domestic corporation are held (directly or indirectly) by foreign persons. And if that domestic corporation is a foreign-controlled domestic corporation, its REIT shares are treated as held by a foreign person for purposes of DC-REIT ownership testing. In other words, the 2024 Regs treat a domestic corporation as a "look-through" entity for DC-REIT ownership testing purposes.
The corporate look-through rule of the 2024 Regs applies differently depending on whether the domestic corporation REITs whose shares are publicly-traded (PT-REITs) or not (Private REITs). In each case, the look-through rule can be a significant compliance burden for a REIT.
ELIMINATING THE LOOK-THROUGH RULE
The Proposed Regulations, if finalized as proposed, would eliminate the look-through rule for domestic corporations. In that case, REIT stock held by a domestic corporation would be treated as held by a U.S. person, not a foreign person, regardless of who owns stock of the domestic corporation.
Assuming the Proposed Regulations are finalized as proposed, the provisions would become effective on the date the final regulations are issued. However, taxpayers can cause the new rules to have a retroactive effect. Taxpayers can elect to apply the new rules back to the date of the 2024 Regulations.2
Footnotes
1 A nonresident alien or foreign corporation.
2 Unfortunately, some share transactions (distributions or sales) might have been subject to FIRPTA that would not have been but for the corporate look-through rule. The foreign persons who paid those FIRPTA taxes may need to file amended returns to obtain a refund of those FIRPTA taxes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
