On April 24, 2024, the Treasury Department promulgated final regulations regarding the requirements for a qualified investment entity (QIE) to be considered a domestically controlled QIE (DC QIE) for purposes of Sections 897 and 1445,¹ such Sections more commonly known as FIRPTA (the regulations finalize proposed regulations issued on Dec. 29, 2022).

DC QIE status is an exception to the general rule that the disposition of a U.S. real property holding corporation (USRPHC) by a non-U.S. person is subject to Foreign Investment in Real Property Tax Act (FIRPTA) tax withholding. Specifically, the sale of stock in a USRPHC² that qualifies as a DC QIE by a non-U.S. shareholder is not subject to FIRPTA tax withholding. A Real Estate Investment Trust (REIT) qualifies as both a QIE and a USRPHC.³ Accordingly, many REIT investments by non-U.S. persons rely on the DC QIE exception, and REIT sponsors who anticipate material non-U.S. ownership generally attempt to structure the ownership of the REIT to qualify as a DC QIE. A REIT generally qualifies as DC QIE under FIRPTA only if the value of stock held by non-U.S. persons, directly or indirectly, is less than 50% of the overall stock value of the REIT (and certain other requirements are met).⁴

The proposed regulations, surprisingly to many industry experts, defined the term “indirectly” for purposes of qualifying as a DC QIE to include a relatively broad “look-through rule” to determine beneficial ownership of a QIE. Under the proposed regulations, a “look through” rule applied to determine ownership of a QIE by a privately held Subchapter C corporations if non-U.S. persons hold directly or indirectly 25% or more of the fair market value of the corporation’s outstanding stock.⁵ Prior to the issuance of the proposed regulations, many REIT sponsors and non-U.S. investors considered indirect ownership only with respect to flow-through entities (such as partnerships and Subchapter S corporations) and relied on the use of a domestic corporation as a “blocker” (no matter the level of foreign ownership) for purposes of determining whether a REIT qualified for DC QIE status.⁶ Aside from disrupting this common industry practice, the proposed regulations generated alarm (and a rush for tax insurance) due to commentary that indicated the new rules might have retroactive effect on an entity structured before the date of the proposed regulations with respect to any transaction occurring on or after the date the proposed regulations are issued in final form.⁷

Notwithstanding the submissions by many commentators arguing for the withdrawal of any look-through rule as applied to a domestic Subchapter C corporation, the final regulations retain a form of look-through rule applicable to certain domestic Subchapter C corporations with “retroactive” application to transactions occurring after the publication of the final regulations, with certain taxpayer-favorable modifications. The final regulations replace the 25% ownership threshold with a 50% ownership threshold for purposes of determining DC QIE status by looking through to the direct and indirect owners of a non-public domestic Subchapter C corporation shareholder of a QIE.⁸

To address concerns regarding retroactivity, the final regulations adopt a transition rule for existing QIE structures. For a ten-year period, a QIE structure that has existed prior to the date of the final regulations (i.e., April 24, 2024) is exempt from application of the new look-through rule to a non-public domestic Subchapter C corporation as long as the QIE continuously maintains DC QIE status (without regard to the new domestic Subchapter C Corporation look-through rule), acquisitions of new U.S. real property interests (USRPIs)⁹ have not become more than 20% of the aggregate fair market value of the QIE’s portfolio of all USRPIs held by the QIE as of the date of the final regulations, and the percentage of stock (based on fair market value) of the QIE held by non-look-through persons (generally domestic Subchapter C corporations and individuals) does not increase by more than 50% in the aggregate over the percentage owned by such non-look-through persons on the date of the final regulations.¹⁰ Although ownership of a QIE (either directly or through one or more look-through persons) by a non-look-through person is not attributable to any other person, a non-public domestic Subchapter C corporation is treated as a look-through person if more than 50% of the value of its stock is held directly or indirectly by non-U.S. persons (a “Foreign Owned Corporation”). The regulatory preamble to the final regulations clarifies that the requirements of the transition rule are intended to permit business arrangements for which binding commitments existed before the date of the final regulations, while prohibiting QIEs from taking actions considered abusive of the relief provided.

Existing single-asset or limited-purpose REITs that rely on domestic corporations as “blockers” for purposes of qualifying for DC QIE status have less risk of losing DC QIE status than multi-asset private REITs operating on an open-ended (a/k/a evergreen) fund model because the former are less likely to acquire new USRPIs and ownership remains relatively static. As a result, such a REIT is more likely to satisfy the transition relief criteria for the remaining holding period of any non-U.S. shareholders (assuming a disposition of REIT shares occurs before the expiration of the relief period). Open-ended funds relying on the transition relief to maintain DC QEI status, in contrast, will be required to assess regularly both any changes in the identity of its non-look-through shareholders (treating a Foreign Owned Corporation as a look-through person) and the impact of additional real estate acquisitions and dispositions to determine whether the REIT has maintained DC QIE status. Such a REIT might be required to restructure in order to preserve DC QIE status.

REITs that do not expect to maintain DC QIE status due to the new look-through rules, as well as their non-U.S. investors, should consider both investment strategies and ongoing ownership structures before considering disposition opportunities.

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• ¹ Subchapter and Section references refer to subchapters and sections of the Internal Revenue Code of 1986, as amended.
• ² A USRPHC generally is a corporation with more than 50% of its value attributable to domestic real estate.
• ³ An entity is a QIE generally if the entity is a REIT or a regulated investment company (a RIC).
• ⁴ See Section 897(h)(4)(B).
• ⁵ Proposed § 1.897–1(c)(3)(v)(B).
• ⁶ The use of a domestic corporation for this purpose was considered reasonable by many for a number of reasons, and some considered the proposed regulations to be inconsistent with congressional intent. The IRS addressed some of these concerns via commentary in the final regulations and rejected the automatic “blocker” approach, making a look-through approach binding on taxpayers upon publication of the final regulations.
• ⁷ See https://www.federalregister.gov/d/2022-27971/p-36. “The IRS may challenge contrary positions before the issuance of any final regulations regarding the treatment of a QFPF or QCE for purposes of the DC-QIE exception.”
• ⁸ Treas. Reg. 1.897-1(c)(3)(v)(B) applies look-through treatment with respect to a “foreign-controlled domestic corporation,” defined as any non-public domestic Subchapter C corporation if foreign persons hold directly or indirectly more than 50% percent of the fair market value of that corporation’s outstanding stock.
• ⁹ A USRPI generally is real estate located in the United States, including certain entities holding real estate.
• ¹⁰ See §1.897-1(c)(3)(vi) for the mechanics of transition relief.