This alert will focus on those elements that finalize the REIT section of proposed regulations published on December 29, 2022, which addressed the definition of a domestically controlled REIT.
The final regulations impact foreign persons that own stock in a REIT that would be a United States real property interest (USRPI) if the REIT was not domestically controlled. The final regulations generally maintain the approach of the proposed regulations despite the tax community’s criticism. However, as described below, they did liberalize the ownership testing threshold and included a generous 10-year transition period. The final regulations are effective April 25, 2024.
Background- Section 897 Domestically Controlled REIT
Gain realized by a foreign person on the disposition of an interest in a ‘domestically controlled (DC) REIT that primarily holds US real property is excluded from taxation under the Foreign Investment in Real Property Tax Act (FIRPTA). A REIT is treated under Section 897(h)(4) as a DC REIT if non-US persons, directly or indirectly, own less than 50% of the value of the REIT during the shortest of (1) the five-year period ending on the date of disposition; or (2) the period during which the REIT existed (the Testing Period).
Section 897 does not define “indirect” ownership for this purpose. To fill in this gap, both the proposed regulations and the final regulations create a “look through” rule for a domestic corporation that owns REIT stock in determining indirect ownership of a REIT.
Section 897 regulation look through rules
For purposes of determining DC REIT status, the final regulations adopt the general approach provided by the proposed regulations of dividing REIT owners into two categories - “look-through persons” and “non-look-through persons.” In general, a REIT treats a “non-look-through person” as the tax owner of the REIT. A “look-through person” is not treated as the tax owner of the REIT; instead, the owners of the “look- through person” are treated as the tax owners.
For purposes of determining the foreign ownership percentage in a REIT, the proposed regulations treated a non-public, domestic C-corporation as a “look-through person” if foreign persons hold, directly or indirectly, a 25% or greater interest by value in the stock of the C corporation. (a “foreign-owned domestic corporation”); i.e., the tax owners of the REIT were the shareholders of the domestic C corporation.
The final regulations increase that threshold to foreign ownership of more than 50% and changed the relevant term to a foreign-controlled domestic corporation.
Mazars’ insight
A publicly-traded, domestic C corporation shareholder of a REIT is per se not a foreign-controlled domestic corporation. The change from 25% or greater foreign ownership in a non-public domestic corporation to more than 50% will reduce the number of domestic corporations treated as foreign-controlled corporations.
Transition rule
In response to the tax community’s concerns, the final regulations include a transition rule that exempts existing structures from the new look-through rule for a ten-year period, provided they meet certain requirements. These requirements are intended to ensure that the final domestic corporation look-through rule does not apply to pre- existing business arrangements, but only to the extent the existing REIT does not acquire a” significant amount” of new USRPIs and does not undergo a “significant change” in its ownership.
A REIT is considered to have acquired a “significant amount” of new USRPIs if the total fair market value of the USRPIs it acquires directly and indirectly exceeds 20% of the fair market value of the USRPIs held directly and indirectly by the REIT as of April 25,
2024.
A “significant change” in the ownership of a REIT occurs if the direct or indirect ownership of the REIT by “non-look-through persons” (determined by applying the final domestic corporation look-through rule) has increased by more than 50 percentage points in the aggregate relative to the REIT stock owned by such “non-look-through persons” on April 25, 2024. The final regulations disregard transfers by any person (regardless of whether they are a non-look-through person) who owns a less than 5% interest in the publicly-traded stock of the REIT unless the REIT has actual knowledge of that person’s ownership.
Mazars’ insight
Existing structures are unimpacted as long as they meet the above transitional rules. The preamble clarifies that the final regulations are prospective only. The transition rule eliminates the proposed regulations’ retroactive applicability date for determining whether a REIT is domestically controlled. Taxpayers should review their existing calculations of domestically controlled REIT status as well as structure new REITs with these rules in mind.
Treatment of qualified foreign pension funds (QFPF) and qualified collective investment vehicles (QCIV) for purposes of the domestically controlled test
Some taxpayers interpreted the statutory provision as indicating that a QFPF is not treated as a foreign person for purposes of determining domestic control. The general consensus of the tax community was that they were foreign for DC REIT purposes. The
final regulations adopt the proposed regulations’ rule confirming that QFPFs and QCIVs are treated as foreign persons for purposes of section 897 DC REIT status.
Ownership of US publicly-traded REIT stock
The proposed regulations provided that a person holding less than 5% of the stock of a US publicly-traded REIT is treated as a US person who is a “non-look-through person” with respect to that stock unless the REIT has actual knowledge that such person is not
a US person.
The final regulations modify the rule to provide that it will also not apply if the REIT has actual knowledge that such person is foreign-controlled.
Section 1445 withholding on dispositions of USRPI
The final regulations clarify the procedures available to a transferor to certify to a transferee that no withholding is required because the DC REIT exception applies. The final regulations confirm that a REIT may provide a statement in response to a request from a transferor certifying that an interest in the REIT is not a USRPI because the REIT is a DC REIT, which the transferor may furnish to the transferee, provided the statement issued by the REIT otherwise complies with the regulatory requirements.