January 9, 2023

Proposed FIRPTA Regulations: Possible Impact on Domestically Controlled Qualified Investment Entities

Proposed FIRPTA Regulations: Possible Impact on Domestically Controlled Qualified Investment Entities International Tax

On December 28, 2022, the Treasury Department released proposed guidance that will impact the way foreign investors invest in U.S. real estate. The proposed regulations clarify the definition of domestically controlled qualified investment entities (“DCQIE”) for purposes of Section 897.

In general, under U.S. statutory law, gains are sourced to the seller’s country of residence. A primary exception to the general rule, however, occurs when the gain is attributable to the sale or exchange of U.S. real property. Section 897 states that a gain or loss from the disposition of a U.S. real property interest (“USRPI”) by a nonresident alien individual or a foreign corporation shall be considered as if the taxpayer were engaged in a U.S. trade or business within the U.S. and such gain or loss were U.S. effectively connected income with such trade or business.

USRPI includes any interest in real property located in the United States or the Virgin Islands and any interest in a domestic corporation if the fair market value of its assets consists of 50 percent or more of U.S. real property interests. U.S. real property interests do not include any interest in any DCQIE. Qualified investment entities (“QIE”) include real estate investment trusts and regulated investment companies that are U.S. real property holding corporations. To be considered a DCQIE, at least 50% of the entity by value is required to be owned by a U.S. person(s), directly or indirectly, during the applicable testing period.

Under existing law, DCQIEs are not required to look through nonpublic domestic C-corporations to determine their domestically controlled status. Under the proposed guidance, if a non-public domestic C-corporation is 25 percent or more owned directly or indirectly by foreign persons, it is considered a foreign-owned domestic corporation (“FODC”). A FODC is considered a look-through entity for purposes of determining DCQIE status and its shareholders should also be considered in determining DCQIE status.

After factoring in the new look-through provisions, if U.S. persons own less than 50% of an entity during the testing period, Section 897 will apply to the foreign owners, and foreign owners with direct interests in the DCQIE will be subject to U.S. income tax on the sale or exchange of their interests.

The regulations under Section 897 are proposed to apply to transactions on or after the date these regulations are published as final.

For additional information on domestically controlled qualified investment entities, contact your Marcum tax professional.