Tax Notes Publishes Joshua R. Williams and Doug W. Scott Article on FIRPTA 5% Exception for Publicly Traded Stock

Tax Notes has published “FIRPTA 5 Percent Exception Should Be Tested at the Partner Level” by Akin tax partner Joshua R. Williams and associate Doug W. Scott. This past spring the IRS asserted in a generic legal advice memorandum (“AM 2023-003”) that in determining whether a foreign partner in a partnership that owns U.S. real estate assets is subject to the requirements of the 1980 Foreign Investment in Real Property Tax Act (“FIRPTA”), the 5 percent ownership threshold for regularly traded stock should be tested at the partnership level. In the article, Williams and Scott argue that the 5 percent threshold should be tested at the partner level, contrary to the position taken by the IRS in AM 2023-003.

The 5 percent ownership threshold, often referred to by tax practitioners as the “regularly traded exception,” is an important exemption from the FIRPTA regime and is regularly relied upon by investment funds to avoid FIRPTA tax and filing consequences otherwise associated with portfolio investments in U.S. corporations with significant real estate related assets. Testing the 5 percent ownership threshold at the partnership level means that if a partnership owns more than 5 percent of a class of regularly traded stock of a U.S. real property holding corporation (a “USRPHC”), each foreign partner, regardless of its proportionate interest in the USRPHC, would be required to treat gain from the sale of such stock as gain effectively connected with the conduct of a U.S. trade or business (i.e., as “ECI”). This is meaningful to many investment funds, since real property has a broad definition for purposes of determining whether a company is a USRPHC and investment managers routinely use partnerships as aggregators and at other levels of their fund structures.

AM 2023-003 is the first published guidance from the IRS on an issue that has long been the subject of uncertainty and debate. While not binding on taxpayers, AM 2023-003 is likely reflective of the IRS’s current audit position. Accordingly, Williams and Scott believe it is important to highlight the significant arguments that exist in support of testing the 5 percent threshold at the partner level. Williams and Scott call for regulations to be issued clarifying that the 5 percent threshold should be tested at the partner level.