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The Treasury and the IRS issue final regulations regarding domestically controlled companies

  1. Entry

On April 24, 2024, the United States Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued final regulations(1) regarding the definition of “domestic controlled” real estate investment trusts (“REITs”). (“Final Regulations”). The Final Regulations retain the controversial “domestic company controlled by a foreign company review rule” from the proposed regulations, under which a domestic company must be “screened” to its owners to determine whether a REIT is domestically controlled, but the rule is narrowed to apply only to private equity domestic companies, the number of which exceeds 50% are owned, directly or indirectly (by value), by non-US owners and not 25%-or more (which was the threshold provided for in the proposed regulations). The final regulations also add a limited 10-year transition rule for certain investors in existing REIT structures.

The Final Regulations are effective from April 25, 2024.

  1. Background

Section 897 of the Code(2), enacted as part of the “Foreign Investment in Real Estate Act” or “FIRPTA”, subjects a non-U.S. person to U.S. tax on any gain recognized on the disposition of a “U.S. real estate interest” (“USRPI”) at the ordinary US tax rates. USRPI includes real estate located in the United States or the Virgin Islands, as well as equity interests in a domestic “U.S. real estate holding corporation” (“USRPHC”), which is typically a corporation whose assets constitute 50% or more of the USRPI by value.

However, an equity interest in a “domestic controlled qualified investment entity” (which includes REITs) is not USRPI. Therefore, a non-U.S. investor can sell interests in a domestically controlled REIT without being subject to U.S. income tax under the FIRPTA rules.

A REIT is domestically controlled if less than 50% of its shares by value are “directly or indirectly” held by foreign persons (i.e., 50% or more of its shares are owned by U.S. persons) at all times during which period during which the REIT REIT existed or, if shorter, the five-year period ending on the date of sale of the shares in the REIT.

Final regulations

Domestic corporations controlled by foreign entities

The final regulations provide that, in order to determine whether a REIT is nationally controlled, all “viewers” are subject to a background check against their owners. A viewer is anyone other than a “non-viewer.” A “non-transparent person” is any individual, any domestic C corporation other than a “domestic corporation controlled by a foreign corporation”, certain publicly traded REITs or regulated investment companies (“RICs”), any non-taxable holder, any foreign corporation or foreign government, any public company (domestic or foreign), any estate (domestic or foreign), any international organization, any qualified foreign pension fund (“QFPF”), and any foreign trust or corporation owned directly or indirectly by a QFPF.

Pursuant to the Final Regulations, a “domestic company controlled by a foreign entity” (controlled) is a non-public domestic company with over 50% are owned, directly or indirectly (by value), by non-US owners. The proposed regulations provided that non-public domestic companies, i.e 25%-or larger, owned by non-US owners are reviewed. Therefore, the Final Regulations are more taxpayer-friendly than the proposed regulations. Nevertheless, the Final Regulations will limit the ability of foreign investors to invest in REITs through a domestic blocking mechanism to ensure that the REIT is treated as domestically controlled.

The principle of transition

The final regulations exempt an existing REIT from the foreign-controlled domestic corporation “look-through” rule for up to ten years if (i) the aggregate fair market value of any USRPI acquired by the REIT directly or indirectly after April 25, 2024 exceeds more than 20% of the aggregate the market value of the USRPI held directly or indirectly by the REIT as of April 25, 2024(3), and (ii) the percentage of shares of the REIT held directly or indirectly by one or more non-viewers does not increase by more than 50 percentage points in the aggregate from the percentage of REIT shares owned directly or indirectly by non-viewers.

For purposes of the first condition of the transition rule, a direct or indirect acquisition of USRPI or REIT shares pursuant to a written agreement that was in force before April 25, 2024 is treated as being held before April 25, 2024.

For purposes of the second condition, (i) the transferor company and the resulting F reorganization company are treated as the same company, and (ii) a class of publicly traded REIT stock that is owned by less than 5% of the stockholders is treated as if is owned by one person and is not privy to (unless the REIT has actual knowledge of any person’s ownership).(4)

The transitional rule will cease to apply to transactions taking place on or after the earlier of (i) the day immediately following the date on which the requirements were not met and (ii) 24 April 2034 (i.e. 10 years after the entry into force date of the Final Regulations).

Section 892 Guidelines

The Final Regulations omit guidance under the Proposed Regulations relating to the exemption of foreign governments under Art. 892 on US federal income tax. The preamble to the Final Regulations states that these guidelines will be included in separate legal acts.

Possible structuring in the light of the final provisions

As mentioned above, without verification, a domestic C corporation cannot be owned more than 49.9% by non-US persons. However, shareholder loans by non-U.S. shareholders may mitigate the effects of the Final Regulations.(5) However, if the shareholder loan is used by non-U.S. shareholders of a domestic C corporation and those shareholders are ineligible for benefits, a U.S. tax treaty that provides for a zero interest rate withholding , the holdings of these shareholders would generally be limited to 9.9% in order to benefit from the portfolio interest exemption.(6)

As shown in the figure below, with 90% leverage and zero interest rate treaty investors, only 2.51% of capital would need to come from unrelated U.S. investors (or 4.51% for non-treaty investors).

For example, assume that a REIT requires $100 in financing. Non-U.S. investors under a zero-interest rate agreement could directly finance the REIT with $49.90, contribute $2.50 in capital to the U.S. corporation, and make a loan of $45.09 to the U.S. corporation. Unrelated U.S. investors would only have to contribute $2.51 in capital to the U.S. C corporation, which would be 50.10% of the equity.

If non-US investors do not qualify for the tax treaty, they would fund the REIT directly with $49.90, make a loan of $45.09 and purchase 9.9% equity for $0.50. Unaffiliated U.S. investors would contribute $45.01 in capital for 90.1% of C Corporation’s equity.


(1) TD 9992.

(2) All references to “sections” refer to the Internal Revenue Code of 1986, as amended, or to the Internal Revenue Regulations promulgated thereunder.

(3) For these purposes, the fair market value of USRPI is the value of that property calculated in accordance with Art. 851(b)(3) or Art. 856(c)(4) as of the last quarter of the REIT’s fiscal year preceding the effective date of the Final Regulations.

(4) There is some similarity between the transitional rule and the “change of ownership” rule in Art. 382 because both rules include the concepts of “50 percentage point increase” and “5% shareholder”. It remains to be seen whether the IRS will interpret the pass-through rule in a similar manner to the change-of-ownership rule (Section 382 limits the carryforward of net operating losses and certain built-in losses after a “change of ownership”).

(5) Loans are presumed to be considered indebtedness for U.S. federal income tax purposes.

(6) If the non-U.S. owner is resident in a jurisdiction with a U.S. tax treaty that provides for a zero interest rate withholding, the non-U.S. owner may own up to 49.9% of a domestic C corporation. Otherwise (and in the absence of a “decontrol” structure) for a domestic C corporation), a non-US owner would be limited to 9.9% to receive interest on a loan to a domestic C corporation without US withholding tax under the portfolio interest exemption.

Rita N. Halabi contributed to this article.