Recent regulations affect US real estate investments

Editor: Christine M. Turgeon, CPA

By the end of 2025, Treasury and the IRS had proposed regulations under Sec. 897 applicable to domestically controlled real estate investment trusts (DC REITs) (the 2025 proposed regulations, REG–109742–25) and finalized regulations under Sec. 892 affecting real property investments by foreign governments (T.D. 10042). (More recently proposed regulations under Sec. 892 (REG–101952–24) are not addressed here.) While certain open questions remain, these new rules provide clear guidance for real estate sponsors and their non–U.S. investors on structuring U.S. real property investments. This item provides background and a summary of the 2025 changes and discusses certain practical implications.

DC REITs

FIRPTA: The Foreign Investment in Real Property Tax Act (FIRPTA) (Title XI, Subtitle C, of the Omnibus Reconciliation Act of 1980, P.L. 96-499, as amended) generally treats gain from dispositions of U.S. real property interests (USRPIs) by a non-U.S. person as effectively connected income, requiring the filing of a U.S. federal income tax return and the payment of tax. USRPIs include interests in U.S. corporations ifthe fair market value (FMV) of the USRPIs equals or exceeds 50% of the FMV of all real property and any assets that are used or held for use in a trade or business, referred to as “United States real property holding corporations” (USRPHCs; Sec. 897(c)(2)). Sec. 897(h)(2) excludes DC REIT stock from USRPI treatment. Therefore, whether a REIT is domestically controlled could make the difference between a non-U.S. shareholder paying no tax and filing no return on a stock sale, versus having to do both.

A REIT is domestically controlled if foreign persons directly or indirectly hold less than 50% of its stock value during a five–year lookback testing period (Sec. 897(h)(4)(B)). The 2025 proposed Sec. 897 regulations focus on this “directly or indirectly” test.

Domestic control: Pre–2022 ambiguity: Before 2022, the “directly or indirectly” language created uncertainty as to whether an interest held by a domestic corporation with non–U.S. owners should be looked through to its ultimate shareholders. One item that could be viewed as support for not looking through was the statute’s specific inclusion of a lookthrough rule for nonpublic REITs. That rule could be considered superfluous if lookthrough applied to all corporations, because REITs are corporations. Further, in 2009, Private Letter Ruling 200923001 (revoked Dec. 6, 2024, by Private Letter Ruling 202449011) concluded that lookthrough did not apply to two domestic corporations’ foreign shareholders for DC REIT determination purposes. Uncertainty regarding this determination remained until additional guidance was issued.

Proposed and final regulations require lookthrough: In 2022, the IRS and Treasury proposed regulations that included lookthrough rules for foreign-controlled domestic corporations (FCDCs) (REG-100442-22). These regulations were finalized in 2024 (the 2024 final regulations, T.D. 9992) and required lookthrough for domestic corporations owned more than 50% by foreign shareholders. Transition rules allowed REITs to be considered domestically controlled for up to 10 years if they met certain asset and ownership tests.

The complexity and ambiguity of these regulations placed significant burdens on taxpayers. They changed the rules of the road for existing REITs with U.S. corporate owners and required REITs to inquire about the ownership of their U.S. corporate owners (which in many cases was dynamic), creating administrative burdens and making it harder for REITs to be domestically controlled if they are owned by majority non–U.S.-owned corporations, presenting a potential capital–raising obstacle.

2025 Proposed regulations repeal lookthrough: In October 2025, Treasury issued the 2025 proposed regulations to repeal the FCDC lookthrough rule. Treasury noted stakeholder feedback and indicated that the prior use of “indirectly” to impose the lookthrough rule was inconsistent with the statutory text and purpose of the DC REIT exception. Taxpayers can apply the proposed regulations, once final, to transactions treated as occurring on or after April 24, 2024, and can rely on the proposed regulations for transactions occurring before finalization. These rules brought welcome relief and can help facilitate DC REIT determinations because REITs no longer will need to look through U.S. corporate shareholders.

Outstanding REIT issues

REIT certification considerations: While the 2025 proposed regulations are generally taxpayer–friendly, certain REITs may be reluctant to issue certifications to foreign persons that their interests are not USRPIs (i.e., by confirming their DC REIT status) because the lookthrough rule repeal remains proposed, notwithstanding the permissive reliance provision in the proposed rules. Generally, 15% gross FIRPTA withholding is required if a non–U.S. person transfers an interest in a corporation and the corporation does not certify its interests are not a USRPI (Sec. 1445(a)). This cautious approach could prompt purchasers to apply FIRPTA withholding as a default measure, potentially resulting in increased reliance on negotiated FIRPTA escrow arrangements.

Five–year testing period considerations: DC REIT determinations during the five–year lookback period raise both interpretive and practical challenges. Ownership changes during this time frame could complicate analyses, especially when the period covers both the 2024 final regulations and the 2025 proposed regulations. For parts of the five–year span, the lookthrough rule may have applied, raising questions about which rules should govern and how conflicting rules should be reconciled in a single assessment. Addressing these issues could lead to differing perspectives between buyers and sellers on potential FIRPTA exposure and drive increased demand for formal tax opinions.

Structural implications and use of domestic blockers: To reduce uncertainty about indirect foreign ownership, domestic C corporation blocker structures could become more appealing when sponsors want to offer foreign investors clearer exit strategies. However, using blockers brings potential corporate tax “leakage” and increased complexity related to base–erosion and anti–abuse tax and corporate alternative minimum tax provisions that apply to certain large C corporations.

Sec. 892 final regulations

Sec. 892 exempts certain categories of income earned by foreign governments from U.S. federal tax, provided the income is not derived from commercial activities, a controlled commercial entity (CCE), or the sale of a CCE. A foreign government engaged in commercial activity is subject to tax on any income derived therefrom and jeopardizes its Sec. 892 exemption for all its income (even if unrelated to that activity); therefore, it is crucial to determine what qualifies as a commercial activity and when a sovereign has control of an entity.

In December 2025, Treasury finalized several long-pending regulations under Sec. 892 (T.D. 10042), with the stated objective of clarifying the scope of “commercial activity” and the circumstances under which an entity is treated as a CCE.

Deemed–commercial–activity rule narrowed: Under prior regulations, domestic or foreign corporations that were USRPHCs were deemed to be engaged in commercial activities, which could cause a controlled entity to be treated as a CCE. Thus, controlled entities of a sovereign needed to monitor their U.S. real estate holdings to prevent becoming a USRPHC, meaning they would limit those holdings or require information reporting from sponsors. The final regulations narrow this rule to apply only to domestic corporations. As a result, sovereigns no longer need to be concerned about their controlled entity losing Sec. 892 benefits merely because they hold too much U.S. real estate. The final regulations also generally permit domestic holding companies that own only minority positions in real estate—heavy corporations to avoid automatic CCE treatment.

Qualified partnership interest exception: A key feature of the final Sec. 892 regulations is the qualified partnership interest (QPI) exception (Regs. Sec. 1.892-5(d)(5)(iii)). A foreign government or controlled entity generally will not be treated as engaged in commercial activity solely by reason of holding a QPI (i.e., a noncontrolling partnership interest). An interest qualifies as a QPI if the holder does not have (1) personal liability for claims against the partnership; (2) the right to legally act on behalf of the partnership; (3) the right to participate in the management or conduct of the partnership’s business; or (4) control of the partnership within the meaning of Regs. Sec. 1.892-5(a)(1) (i.e., holds, directly or indirectly, 50% or more of the total interests in the partnership or any other interest that provides it with effective control).

The final regulations include a de minimis safe harbor for 5%-or–less partnership interests (that also meet other requirements), which are automatically treated as QPIs (Regs. Sec. 1.892–5(d)(5)(iii)(C)). Although the QPI exception prevents attribution of a partnership’s commercial activities to a sovereign, any income directly attributable to the partnership’s commercial activities remains ineligible for the Sec. 892 exemption and must be reported on an income tax return.

Hedging activities: The final regulations include an exception for derivatives as “financial instruments,” the ownership of which does not alone rise to the level of a commercial activity. Sovereigns engaging in hedging activity as a nondealer using derivatives and for their own account can do so without concern that those hedges could constitute commercial activity.

Inadvertent commercial activities: The final regulations include an exception allowing an entity to avoid CCE treatment if it engages in inadvertent commercial activity. To qualify, (1) the failure to avoid the commercial activity must be “reasonable,” which is based on all the facts and circumstances, including having written policies and procedures designed to avoid commercial activities and that responsible employees have taken reasonable efforts to follow; (2) the commercial activity must be cured within 180 days of its discovery; and (3) the entity must maintain records of each commercial activity and actions taken (Regs. Sec. 1.892-5(a)(2)). Note that even where the commercial activities are inadvertent and the entity avoids CCE status, the inadvertent income is still taxable.

Other complexities: The final regulations could ease compliance by removing the need to track USRPHC status for non–U.S. entities holding USRPIs directly, streamlining monitoring for multinational investment structures. However, complex rules could require aggregating (1) sovereign entities from the same country that hold interests in a single partnership or (2) the same sovereign entity across multiple vehicles (e.g., co–investments) to make QPI determinations, which could increase diligence and coordination requirements as ownership levels change.

Editor

Christine M. Turgeon, CPA, is a partner with PwC US Tax LLP, Washington National Tax Services, in New York City.

For additional information about these items, contact Turgeon at christine.turgeon@pwc.com.

Contributors are members of or associated with PwC US Tax LLP.