The IRS has finally taken a view on the exception to FIRPTA (the Foreign Investment in Real Property Tax Act) for publicly traded stock of a United States real property holding corporation (a “USRPHC”) that is held by a partnership, announcing that the exception should be determined at the partnership level, rather than at the partner level.

A foreign person generally is subject to tax in the United States under FIRPTA on any gain from the disposition of a United States real property interest (a “USRPI”), which includes stock in a USRPHC. However, if a class of stock of a corporation is regularly traded on an established securities market, stock of such class is treated as a USRPI only if a person holds more than 5% (10% in the case of a REIT) of such class of stock during the relevant holding period. This exception generally allows a foreign person to trade up to 4.9% of the stock of a publicly-traded USRPHC without a filing requirement during any relevant holding period.

Practitioners have long debated how to apply this exception to stock in a USRPHC that is held by a partnership. The IRS’s Office of Chief Counsel (in Chief Counsel Advice Memorandum 2023-003) recently applied the publicly traded stock exception at the partnership level, determining that if a partnership holds 8% of publicly traded stock in a USRPHC, a foreign partner that owns a 25% interest in the partnership will recognize FIRPTA gain upon the sale of such stock even though on a look-through basis that partner owns only a 2% interest in the stock. The memorandum applied fairly straightforward statutory construction, reasoning that the use of the term “person” in the statute included partnerships, and that it was not more appropriate for a partnership to be treated as an aggregate for this purpose.

This memorandum, while non-binding, is certainly unwelcome news to those taxpayers who have been taking the position that the publicly traded stock exception should be applied on a look-through basis at the partner level. In addition to the potential financial accounting implications, investment funds that have been taking a look-through position could have significant withholding tax exposure for past trades should the IRS decide to audit based on this memorandum. Funds may want to restructure such investments going forward, such as by holding investments above the master-fund level (subject to ERISA considerations). Further, FIRPTA is an expansive statute that applies even to derivative gains on USRPIs, making it difficult to avoid its application through the use of total return swaps or other derivative instruments.