The Treasury Department has released Proposed Regulations under IRC Section 897 to withdraw the domestic corporation look-through rule that was adopted in final regulations issued in 2024 (Proposed Reg. Section 1.871-1, REG-109742-25, published in the Federal Register October 21, 2025)

Introduction to FIRPTA and the DC-QIE Exception

For tax professionals dealing with foreign investment in U.S. real property, the provisions of the Foreign Investment in Real Property Tax Act (FIRPTA), specifically Internal Revenue Code Section 897, are paramount. Section 897(a)(1) mandates that gain or loss recognized by a nonresident alien individual or foreign corporation upon the disposition of a United States Real Property Interest (USRPI) must be treated as income effectively connected with a U.S. trade or business (ECI). A USRPI generally includes interests in real property located in the United States, as well as any interest (other than solely as a creditor) in any domestic corporation unless the taxpayer establishes that the corporation was not a United States real property holding corporation (USRPHC) during the statutory testing period (generally the five-year period ending on the date of disposition). Under Section 897(c)(2), a USRPHC is generally defined as a corporation where the fair market value of its USRPIs meets or exceeds 50 percent of the total fair market value of its USRPIs, foreign real property interests, and trade or business assets.

A critical exception exists for interests in a domestically controlled qualified investment entity (DC-QIE). Section 897(h)(2) provides that a USRPI does not include an interest in a DC-QIE. Consequently, gain or loss realized upon the disposition of stock in a DC-QIE is not subject to tax under Section 897(a). A Qualified Investment Entity (QIE) is defined under Section 897(h)(4)(A) as any real estate investment trust (REIT) or any regulated investment company (RIC) that is or would be a USRPHC. A QIE qualifies as domestically controlled if less than 50 percent of the value of its stock is held directly or indirectly by foreign persons at all times during the testing period prescribed in Section 897(h)(4)(D).

Evolution of the Look-Through Rule for Domestic C Corporations

The determination of whether stock in a QIE is held "directly or indirectly" by foreign persons, for purposes of the DC-QIE definition under Section 897(h)(4)(B), was addressed by proposed regulations (REG-100442-22) published in December 2022. These 2022 proposed regulations set forth rules for determining stock held "indirectly" by utilizing a limited "look-through" approach. Under that approach, only a "non-look-through person" is treated as holding stock directly or indirectly, and stock held through a "look-through person" is treated as held proportionately by the ultimate non-look-through owners.

The 2022 proposed regulations generally treated a domestic C corporation (defined as any domestic corporation other than a RIC, REIT, or S corporation) as a non-look-through person. However, the 2022 proposed regulations introduced a domestic corporation look-through rule that treated certain non-publicly traded domestic C corporations as look-through persons if foreign persons held a 25 percent or greater interest (by value) in the corporation’s stock.

On April 24, 2024, the Treasury Department and the IRS published the 2024 final regulations (TD 9992), which retained this general structure but revised the domestic corporation look-through rule. Under the 2024 final regulations, the rule applied if foreign persons held a more than 50 percent interest (by value) in the stock of the corporation. This requirement was implemented in Treasury Regulation 1.897-1(c)(3)(iii)(B) and (c)(3)(v)(B). The 2024 final regulations also included a transition rule that temporarily exempted existing QIEs from this look-through rule for ten years, provided there was no significant change in the QIE's USRPIs or ownership (see Treasury Regulation 1.897-1(c)(3)(vi)).

Justification for the Proposed Regulatory Removal

Following the publication of the 2024 final regulations, the Treasury Department and the IRS received significant feedback recommending the withdrawal of the domestic corporation look-through rule.

The feedback focused on practical difficulties, specifically the challenge of tracing upstream ownership, often without access to reliable data. This complexity generated legal uncertainty, operational complications, and threatened to have a chilling effect on investment in U.S. real estate.

In addition, taxpayers argued that the domestic corporation look-through rule conflicted with the statutory framework and congressional intent. They noted that Section 897(h)(4)(B) itself does not contain explicit corporate look-through rules. They asserted that Congress provided look-through treatment for certain corporate owners of QIEs only in the specific circumstances described in Section 897(h)(4)(E), implying that the omission of a similar general rule in Section 897(h)(4)(B) was intentional. Imposing a corporate look-through rule under Section 897(h)(4)(B) would arguably render the look-through rules of Section 897(h)(4)(E) surplus. Finally, arguments were made that because a domestic corporation's interests are already subject to U.S. corporate income tax, the objective of Section 897 is already satisfied without needing to look through the domestic corporation.

Treasury and IRS Analysis and Conclusion

In light of the concerns raised regarding compliance difficulty and statutory consistency, the Treasury Department and the IRS reconsidered the interpretation of the term "indirectly" as applied within the domestic corporation look-through rule. This evaluation assessed the rule's consistency with the statutory text and the purpose of the DC-QIE exception, which Congress intended to be available for QIEs controlled by United States persons.

Upon further consideration, the Treasury Department and the IRS concluded that applying look-through treatment to an entity already subject to U.S. taxation (a domestic C corporation) based on a strict 50-percent foreign ownership threshold is not the proper construction to be given to the text of Section 897(h)(4)(B), even when considering traditional tools of statutory construction and the provision’s purpose.

Regulatory Changes under the Proposed Rulemaking

The proposed regulations (REG-109742-25) would modify existing regulations by removing the domestic corporation look-through rule.

If adopted, the proposed regulations would:

Remove the domestic corporation look-through rule (specifically, removing and redesignating paragraphs in Treasury Regulation 1.897-1(c)(3)).
Treat all domestic C corporations as non-look-through persons for the purpose of determining whether a QIE is domestically controlled.

Under the proposed framework, a domestic C corporation is defined as a non-look-through person in the revised Treasury Regulation 1.897-1(c)(3)(v)(D). When a domestic C corporation (which is not a foreign person) holds QIE stock, that stock is considered held directly or indirectly by the domestic C corporation. Importantly, the USRPI stock held by the domestic C corporation is not considered held directly or indirectly by its shareholders. Consequently, the domestic C corporation is treated as a United States person for determining the foreign ownership percentage of the QIE.

The proposed regulations also incorporate necessary conforming revisions throughout Treasury Regulation 1.897-1(c)(3) due to the removal of the look-through rule. Additionally, the prior transition rule pertaining to the look-through rule (formerly Treasury Regulation 1.897-1(c)(3)(vi)) would be removed.

Reliance and Effective Dates

Tax professionals should be aware of the applicability and reliance rules associated with these proposed regulations:

Effective Date if Adopted: If finalized, the regulations would apply to transactions occurring on or after the date of filing in the Federal Register.
Taxpayer Reliance Prior to Finalization: Taxpayers may rely on the proposed regulations for transactions occurring before the date the proposed regulations are finalized.
Optional Retroactive Application: Taxpayers may also choose to apply the final regulations retroactively to transactions occurring on or after April 25, 2024. This optional application also extends to transactions occurring before April 25, 2024, resulting from an entity classification election under Treasury Regulation 301.7701-3 that was effective on or before April 25, 2024, but filed on or after that date.

Prepared with assistance from NotebookLM.