Defining “Attributable to” Under Sec. 897(g)

By Ilene W. Fine, J.D., LL.M., Washington, D.C.

Editor: Annette B. Smith, CPA

Foreign Income & Taxpayers

In general, a foreign person who invests in a U.S. real property interest (USRPI) through a partnership is subject to tax under Sec. 897 on the gain recognized on disposition of the partnership interest to the extent “attributable to” USRPIs held by the partnership (Sec. 897(g)). According to the legislative history, the Foreign Investment in Real Property Tax Act of 1980, P.L. 96-499 (FIRPTA), was intended “to establish equity of tax treatment in U.S. real property between foreign and domestic investors . . . [and] not . . . to impose a penalty on foreign investors or to discourage foreign investors from investing in the United States” (S. Rep’t 96-504, 96th Cong., 1st Sess., 6 (1979)). This underlying intent often is lost in practice—the lack of regulatory and published guidance about the treatment of partnerships has left taxpayers and tax practitioners uncertain about how to identify a reasonable method to determine the amount of gain subject to tax under FIRPTA.

An interest in a domestic corporation can be a USRPI in its entirety if the domestic corporation is a U.S. real property holding corporation at any time during the determination period. However, an interest in a partnership is a USRPI only to the extent of the underlying assets. For purposes of determining the amount of gain subject to tax under Sec. 897, Sec. 897(g) treats the amount of money and the fair market value (FMV) of property received in exchange for a partnership interest, to the extent attributable to a USRPI, as an amount received from the sale or exchange of a USRPI. Accordingly, if a foreign person sells an interest in a partnership that holds both USRPIs and non-USRPIs, Sec. 897(g) requires the foreign person to determine what proportion of the amount realized is attributable to a USRPI.

To date, regulations have not been issued under Sec. 897(g) to clarify how to determine what is attributable to a USRPI when a partnership owns both USRPIs and non-USRPIs. Added complexity arises when the partnership makes various allocations and adjustments that have to be taken into account or when there is a loss on the USRPIs but a gain on the non-USRPIs.

In the absence of guidance, various potential approaches could be applied, each yielding different results. Some of the potential approaches include:

  • Allocating the partner’s selling price and basis based on the relative FMV of the assets on the date of sale;
  • Applying the methodology in Rev. Rul. 91-32, even though the ruling treats the Sec. 897(g) rules as carved out from the treatment it is addressing under Secs. 864(c) and 865(e) (allocating gains to the partner based on relative inside gains inherent in the assets);
  • Determining the relative inside FMVs at both the date of purchase and the date of sale to determine how much of the partner’s basis and selling price is “attributable to” a sale of a USRPI; or
  • Determining the amount of gain allocable to the foreign partner on a hypothetical sale of a USRPI held by the partnership.

Even if the methodology used in Rev. Rul. 91-32 were applied to Sec. 897(g), that approach does not seem to take into account the property’s FMV on the date the partnership interest was acquired and seems unlikely to reflect accurately the partner’s share of appreciation in the asset. The Obama administration’s FY 2014 budget proposed codifying the Rev. Rul. 91-32 methodology. If that legislation is enacted, it might help taxpayers with their calculation under Sec. 897(g).

Although there are various methodologies, each of which may be reasonable in some respect, the starting point for the computation is first to identify the total amount the partner realized on the sale of its partnership interest. The partner then must determine how much of the amount realized is attributable to a USRPI.

In theory, in a basic fact pattern, the amount attributable to a USRPI should be equal to the partner’s inherent gain in the USRPIs held by the partnership by allocating a portion of the amount realized to the amount of the appreciation in the USRPIs between the date the partner purchased the partnership interest and the date the partner sold it. This type of calculation would seem to equate to the amount of gain that would be subject to tax if the foreign partner had owned the property directly. Adjustments likely would be required to take into account the following: (1) liabilities on the USRPI held by the partnership; (2) that the partnership did not already own the USRPI when the foreign partner acquired the partnership interest; (3) that the foreign partner contributed property with a built-in gain in a nonrecognition transaction and the property has since depreciated in value; and (4) that the partner contributed a USRPI with a built-in gain to the partnership in a nonrecognition event.

According to the conference report on the FIRPTA legislation, a foreign investor in a partnership would be taxable on the disposition of the investor’s interest to the extent that the gain represented the investor’s pro rata share of appreciation in the value of USRPIs of the entity. This language seems to suggest that the term “attributable to” a USRPI should be equal to the partner’s pro rata share of the appreciation in the underlying USRPIs. However, in the absence of guidance, the appropriate methodology for making this determination remains unclear.

A similar issue arises in the context of nonrecognition transactions involving the disposition of a USRPI for a partnership interest. In general, FIRPTA overrides nonrecognition provisions unless, among other requirements, the USRPI is exchanged for a USRPI or the transaction is within one of the enumerated foreign-to-foreign nonrecognition transactions set forth in Temp. Regs. Sec. 1.897-6T(b)(1) as modified by Notices 89-85 and 2006-46 (there are no foreign-to-foreign exceptions that apply to partnerships). As stated above, a partnership is a USRPI only to the extent the underlying assets are USRPIs. Thus, presumably, if a foreign person contributes a USRPI to a partnership in exchange for a partnership interest in a Sec. 721 transaction, the USRPI-for-USRPI requirement would seem to be satisfied. However, if the partnership owns non-USRPI assets, it could be argued that the USRPI-for-USRPI requirement is not satisfied in its entirety because some portion of the partnership interest is attributable to non-USRPIs.

The example in Temp. Regs. Sec. 1.897-6T(a)(3) suggests that the exchange of a USRPI for an interest in a partnership will receive nonrecognition treatment only if the partnership interest will be subject to tax under Sec. 897(g). As only a portion of the partnership interest received would be subject to tax under Sec. 897(g), it remains unclear how to apply these rules in the context of a Sec. 721 contribution. It could be argued that the mixed-exchange rules under Temp. Regs. Sec. 1.897-6T(a)(8) should apply so that nonrecognition would be available, but the percentage of the partnership interest received that is attributable to the non-USRPIs would be subject to tax, effectively treating a percentage of the partnership interest as boot.

In summary, the lack of clear legislative history in conjunction with minimal regulatory guidance has created uncertainty in applying Sec. 897 to determine the amount of gain attributable to a USRPI. However, it is important to remember that FIRPTA’s underlying policy goal is to create equity between U.S. and foreign investors. Absent an abusive transaction, a foreign investor should not be placed at a disadvantage when investing in a partnership structure rather than acquiring the property directly. Under this view, it would seem that the calculation for determining the amount of gain attributable to a USRPI under Sec. 897(g) should result in the same amount of gain that the foreign investor would recognize had the property been held directly.


Annette Smith is a partner with PwC, Washington National Tax Services, in Washington, D.C.

For additional information about these items, contact Ms. Smith at 202-414-1048 or

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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