Issues facing partnerships under FIRPTA.

• Author: Smith, Annette B.
• Position: Foreign Investment in Real Property Tax Act of 1980

The legislative history of the Foreign Investment in Real Property Tax Act (FIRPTA, part of the Omnibus Reconciliation Act of 1980, P.L. 96-499) suggests that Sec. 897 was intended to create one set of uniform rules that would apply to domestic corporations, partnerships, and trusts. However, Sec. 897, as ultimately enacted, and the regulations issued there-under primarily address corporations and various corporate transactions. To date, the IRS has not issued meaningful guidance with respect to partnership transactions. This item identifies several issues taxpayers should be aware of to the extent they invest in partnership structures that hold U.S. real property interests (USRPIs).

Partner-or Partnership-Level Determination

FIRPTA adopted the entity theory of partnerships and treats a partnership as a person pursuant to Temp. Regs. Sec. 1.897-9T(c). A common issue in this context is whether a partnership that sells an interest in a publicly traded domestic corporation is eligible for the publicly traded exception under Sec. 897(c)(3). In general, Sec. 897 imposes a substantive tax on gains realized by a foreign person on the sale of a USRPI. Pursuant to Sec. 897(c)(3), a USRPI does not include an interest in a publicly traded corporation if such shares are regularly traded on an established security market, provided that the "person" held 5% or less of the shares during the relevant determination period.

Because the publicly traded test refers to a person, and a partnership is treated as a person, it follows that if a partnership has a 5% or less interest in a domestic corporation that satisfies the publicly traded exception, such interest would not be a USRPI. Consequently, the sale of such interest would not result in gain or loss effectively connected to a U.S. trade or business. The partnership and the domestic corporation would not be obligated to adhere to the reporting requirements that ordinarily are required to establish that an interest in a domestic corporation is not a USRPI (Regs. Sec. 1.897-2(h)(3)). However, there is an argument that the person to be tested for application of the 5% rule is the person that would be taxed on the disposition. Under this theory, the 5% test would apply at the partner level rather than the partnership level. No clear authority exists to resolve this issue.

Amount Attributable to a USRPI

If a partnership has a greater-than-5% interest in a publicly traded corporation and the 5% test is applied...