Shortly before the new year, the Internal Revenue Service (“IRS”) dropped a holiday bombshell on the tax community when it issued a proposed regulation under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”). The proposed regulation would, if enacted in its current form, reverse a longstanding IRS ruling interpreting FIRPTA (the “2009 PLR”) and significantly increase the tax exposure for certain existing foreign investors in fund vehicles that invest in U.S. real estate through REITs. As discussed in this alert, the proposed regulation would appear to apply to currently existing REIT structures that are disposed of after the effective date of the rule, meaning that in certain situations, the proposed regulation will, as a practical matter, have retroactive effect. In addition, and much more ominously, the IRS explicitly reserved the right to challenge positions taken under current law to the extent inconsistent with the proposed regulation. Regardless of whether the final rule incorporates a grandfather clause exempting current REIT structures or pre-finalization REIT sale transactions from its application, however, the rule can be expected to reduce the amount of capital deployed by certain foreign investors in U.S. real estate projects that are held in REIT form and increase the level of structuring effort required by fund sponsors wishing to attract those investors to their future real estate fund vehicles.

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