United States: Final regulations on domestically controlled REITs released

The IRS today released final regulations on what constitutes a domestically controlled REIT. An interest in a domestically controlled real estate investment trust REIT (DC REIT) is not a U.S. real property interest, and a foreign person’s gain on the sale or other disposition of such an interest is therefore not subject to tax or withholding under the FIRPTA provisions of the U.S. Internal Revenue Code.

Although some sovereign wealth and public pension funds are exempt from FIRPTA by virtue of their status as qualified foreign pension funds (QFPFs), DC REIT status may still be relevant for some of their investments and co-investments.

A REIT is domestically controlled if foreign persons hold directly or indirectly less than 50% of the fair market value of the REIT’s stock at all times during the testing period (i.e., in most cases, five years prior to when the relevant gain is recognized).

The final regulations generally follow the proposed regulations and apply a look-through approach to determining whether a REIT is domestically controlled. Stock held by a “look-through person” will be treated as being held by the look-through person’s shareholders, partners or beneficiaries, as applicable, through tiers of look-through persons until the ultimate “non-look-through persons” are identified and their proportionate interests in the underlying REIT determined. Under the final regulations, foreign-controlled domestic corporations are treated as look-through persons. A foreign-controlled domestic corporation is a non-public domestic corporation in which more than 50% of the stock is held directly or indirectly by foreign persons (including QFPFs and foreign governments). By contrast, the proposed regulations had used a 25% foreign-controlled threshold.

The final regulations include a 10-year transition rule for existing structures. The transition rule treats domestic corporations that own REIT shares as domestic even if they would be look-through persons under the final regulations. For the transition rule to apply, U.S. real property interests acquired by the REIT after April 25, 2024, cannot exceed 20% of the total fair market value of all U.S. real property interests the REIT owns and the REIT cannot have a significant change in ownership.  In general, a significant change in ownership occurs when more than 50% of the REIT stock changes ownership (directly or indirectly) compared to ownership on April 25, 2024. Special rules apply for pending transactions. REITs that intend to qualify as domestically controlled based on the transition rule will need to monitor their assets and stock ownership on an ongoing basis.

Subject to the transition rule, the final regulations apply to transactions occurring on or after the date when the regulations are published in the Federal Register (April 25, 2024).

The final regulations do not address the portion of the proposed regulations dealing with the section 892 exemption. The IRS will deal with those separately.

Sovereign wealth funds and public pension funds may wish to:

• Confirm compliance with the final regulations when they currently rely on DC REIT status to avoid FIRPTA in respect of any direct or indirect investments in U.S. real property
• Confirm deal and due diligence teams are aware of these regulations, including for any transactions currently underway
• When relevant, confirm ongoing DC REIT status with third-party asset managers and general partners
• Develop plans to monitor status of DC REIT investments including adherence to transitional rule requirements
• Confirm their QFPF/qualified holder status if DC REIT status is no longer available for some investments

KPMG will provide a more detailed analysis in the coming days.
 

To discuss the effects of these changes, contact any member of the KPMG Sovereign Wealth and Pension Funds Tax team, including:

Janice Russell | janicerussell@kpmg.com

Dan Winnick | danielwinnick@kpmg.com

Josh Kaplan | jskaplan@kpmg.com