Summary of Domestically-Controlled REIT Final Regulations

On April 24, 2024, the IRS issued final regulations to determine whether a REIT will qualify as domestically-controlled.  Although a foreign shareholder of a REIT is normally subject to FIRPTA tax on a sale of its REIT shares, a sale of shares of a domestically-controlled REIT is exempt from FIRPTA tax. These regulations include a welcome change from proposed regulations issued on December 29, 2022, narrowing the scope of a look-through rule that could cause a REIT to fail to be treated as domestically-controlled where a REIT shareholder is a domestic corporation owned by foreign persons. 

Background

A REIT is considered domestically-controlled if less than 50% of the value of its stock is held “directly or indirectly” by foreign persons during the five-year period ending on the sale date or the period which the REIT was in existence, if shorter.

Prior to the release of the 2022 proposed regulations, many foreign investors took the position that where a domestic corporation owns REIT shares, the domestic corporation is counted as a non-foreign shareholder even if the majority of its shareholders are foreign persons.  For example, to reduce a REIT’s percentage ownership by foreign investors, foreign investors could form a domestic corporation that would hold a sufficient number of REIT shares such that, together with other US shareholders of the REIT, the REIT would qualify as domestically-controlled.

Proposed Regulations

Among other things, the proposed regulations adopted a look-through rule for domestic corporations that are “foreign-owned”.  The proposed regulations would look through a domestic corporate shareholder of a foreign-owned REIT, treating its foreign owners as if they held REIT shares directly.  This look-through rule could cause the REIT to fail to qualify as domestically-controlled.  Under the proposed regulations, “foreign-owned” domestic corporations were defined as privately-held domestic corporations, 25% or more of the stock of which is owned, directly or indirectly, by foreign shareholders.

Final Regulations

The IRS received many comments regarding the domestic corporation look-through rule and agreed that the scope of the rule should be narrowed to ensure it is limited to situations where significant indirect ownership by foreign persons indicative of foreign control is present.  As a result, the 25% threshold has been increased to 50%.  Under the final regulations, the look-through rule applies only if the non-public domestic corporation shareholder is more than 50% controlled by foreign persons.

The final regulations are effective as of April 25, 2024.  However, the IRS included a transition rule that would exempt existing structures from the final domestic corporation look-through rule if they meet certain requirements that are intended to ensure preexisting business arrangements are not impacted, but only to the extent that the REIT does not acquire a significant amount of new US real estate assets and does not undergo a significant change in its ownership.