What changed for FIRPTA 2026 and foreign investors?
Cross-border real estate deals sit on a small number of moving parts: whether the seller is a non-U.S. person, whether the target is a United States real property interest, and whether a wrapper such as a REIT or a partnership changes that character. For years, the interaction between those parts and the FIRPTA rules produced uncertainty that showed up as diligence lists, withholding escrows, and long ownership questionnaires. Two Treasury releases in late 2025 reset several of the largest questions, and FIRPTA 2026 is the framework sponsors and their non-U.S. investors are actually operating under this year. This post walks through what changed under 2025 proposed regulations (REG-109742-25) and T.D. 10042, what it means for real estate sponsors and their non-U.S. investors, and where our clients are still being careful.
What did the 2025 proposed regulations change for FIRPTA and DC REITs? 🏢
They repeal the lookthrough rule that treated foreign-controlled domestic corporations as foreign for the domestically controlled REIT test. Under the 2025 proposed regulations, U.S. corporate shareholders are counted as domestic even when they themselves are more than 50% foreign-owned.
Section 897(h)(2) excludes DC REIT stock from the definition of a U.S. real property interest, so a non-U.S. person’s sale of stock in a domestically controlled REIT is not caught by FIRPTA. A REIT is domestically controlled under IRC Sec. 897(h)(4)(B) if foreign persons hold, directly or indirectly, less than 50% of its stock value during a five-year lookback period. The dispute for over a decade was what the phrase “directly or indirectly” meant when the record shareholder was a U.S. corporation with foreign owners.
Treasury and the IRS proposed lookthrough rules in 2022 and finalized them in 2024 as T.D. 9992. Those rules required lookthrough for a foreign-controlled domestic corporation — a U.S. corporation more than 50% foreign-owned — so a REIT’s U.S. corporate shareholder could no longer be treated as domestic without further inquiry. A ten-year transition rule allowed some existing REITs to keep their status if asset and ownership tests were met, but for new structures the rule shifted diligence upstream into shareholder chains that were often dynamic.
The 2025 proposed regulations reverse course. Treasury explained that reading “indirectly” to impose a lookthrough was inconsistent with the statutory text and the purpose of the DC REIT exception. The proposal repeals the foreign-controlled domestic corporation lookthrough rule. Taxpayers may rely on the proposed regulations for transactions treated as occurring on or after April 24, 2024, and can continue to rely on them until final regulations are issued.
From our practice: the diligence conversation gets shorter
In our practice, the biggest immediate effect is that we stop asking sponsors to trace ownership through their U.S. corporate investors’ foreign ultimate parents just to confirm DC REIT status. The analysis stops at the U.S. corporate shareholder. That does not eliminate the domestic control question — it still lives at every closing where a non-U.S. person sells REIT stock — but the record we need to keep is dramatically smaller.
Why are REITs still cautious about issuing FIRPTA certifications? ⚠️
The 2025 rules are still proposed. Some REITs are unwilling to certify DC status until the regulations are final, which pushes buyers toward default 15% withholding under Sec. 1445 and toward FIRPTA escrow arrangements.
Under Sec. 1445(a), a buyer of an interest in a U.S. corporation from a non-U.S. person generally has to withhold 15% of the gross amount unless the corporation certifies its interests are not U.S. real property interests. A DC REIT that would qualify for the exception can issue that certification and take the deal out of the withholding regime. Where the certification is not issued, buyers withhold and sellers claim the excess back on a filed U.S. return.
Some REITs will look at the reliance provision in the proposed rules and issue certifications today. Others will wait until finalization. Where a sale involves a large or contested position, buyers and sellers often bridge the gap contractually — the seller certifies, the buyer withholds into escrow, and the escrow releases when the position is confirmed by finalized rules or by a filed return. Practical diligence checklists should assume both patterns can appear in the market during 2026.
What did T.D. 10042 change under FIRPTA-adjacent Sec. 892? 🌐
It rewrites how a foreign government’s controlled entities are tested for commercial activity — narrowing the deemed rule, adding a qualified partnership interest exception, carving out non-dealer derivatives, and giving an escape hatch for inadvertent activity.
Sec. 892 exempts most passive income of foreign governments from U.S. federal tax, provided the income is not derived from commercial activities, from a controlled commercial entity, or from the sale of one. A single commercial activity by a controlled entity can strip the Sec. 892 exemption from all of that entity’s income, even income unrelated to the activity. The final rules in T.D. 10042 address the most common ways that trap has been sprung on U.S. real estate holdings.
| Rule | Prior treatment | Under T.D. 10042 |
|---|---|---|
| Deemed commercial activity from USRPHC status | Both domestic and foreign USRPHCs were treated as engaged in commercial activity, so a controlled entity could become a CCE just for holding too much U.S. real estate. | Only domestic USRPHCs trigger the deemed rule. Domestic holding companies that own only minority positions in real-estate-heavy corporations generally avoid automatic CCE treatment. |
| Partnership interests | Any partnership commercial activity could be attributed up to the sovereign, requiring careful structuring and side letters. | A qualified partnership interest (noncontrolling, meeting the other requirements at Regs. Sec. 1.892-5(d)(5)(iii)) is not commercial activity for the sovereign. Interests of 5% or less that meet the other requirements are automatically QPIs under a de minimis safe harbor. |
| Hedging derivatives | Uncertain whether entering derivatives for the sovereign’s own account could be commercial activity. | Non-dealer derivatives used for the entity’s own account are treated as financial instruments, not commercial activity. |
| Inadvertent activity | A single unintended act of commercial activity could taint the entity. | An entity can avoid CCE treatment if the failure was reasonable (written policies, employee efforts to follow them), was cured within 180 days of discovery, and is documented. The inadvertent income itself is still taxable. |
These changes will not resolve every structuring question. Aggregation across sovereign entities from the same country and across multiple vehicles is still required for QPI determinations, and an ownership shift can flip a QPI to a controlling interest that has to be reanalyzed. But the final regulations remove several of the traps that had pushed sovereign investors toward heavier, less efficient structures.
A blocker is not always the cheaper answer
When indirect foreign ownership is hard to trace, U.S. C corporation “blocker” structures look attractive because they clarify FIRPTA and Sec. 892 exposure. They also introduce corporate tax leakage, base-erosion anti-abuse (BEAT) exposure for the largest structures, and possible corporate alternative minimum tax under the recent code changes. Model the full stack before choosing a blocker as the default answer.
How should sponsors and non-U.S. investors respond to the FIRPTA and Sec. 892 changes? 🧭
Refresh the DC REIT testing framework, revisit outstanding FIRPTA certifications, and rework Sec. 892 memos for sovereign investors — while keeping the analysis defensible under both the 2024 and 2025 rules for periods within the five-year lookback.
- Refresh the DC REIT testing framework. The five-year lookback under Sec. 897(h)(4)(B) will span both the 2024 final regulations and the 2025 proposed regulations for the next several years. Testing for parts of the period may have to be done under lookthrough rules and other parts under the repealed approach. Where a sale date drives which framework applies, document the choice.
- Revisit FIRPTA certifications and closing mechanics. Decide the firm-wide position on issuing certifications while the rules are proposed, so sponsors are not improvising deal by deal. Where a buyer will still insist on withholding, an escrow release conditioned on finalization or on the seller’s filed return can be a reasonable middle ground.
- Rework Sec. 892 memos for sovereign investors. Take advantage of the narrowed deemed rule, the QPI exception, and the derivatives carve-out to unwind unneeded wrapper entities where the only rationale was the pre-T.D. 10042 concerns. Preserve written policies and evidence of employee training so the inadvertent activity exception is available if it is ever needed.
- Plan for the transition. Some existing structures were built under the 2024 lookthrough rule and its transition relief. Do not dismantle a compliant structure solely because the 2025 proposal is more permissive — until finalization, the safest path is often to preserve the current structure while designing new deals to the newer framework.
- Coordinate with tax counsel on formal opinions. Where a transaction involves a large FIRPTA exposure or a sensitive sovereign fact pattern, a formal opinion under the new framework will often be worth more than an internal memo, given the “proposed” status of the 2025 REIT rules.
Where can I read the primary sources on FIRPTA and Sec. 892 for myself? 📚
Start with the statute at IRC Sec. 897 and IRC Sec. 892, the IRS FIRPTA overview, and the two Federal Register releases: 2025 proposed regulations (REG-109742-25) and T.D. 10042.
Reading the primary sources changes the conversation with sponsors and investors. The statute is short. The regulations are dense but organized, and the preambles explain the Treasury reasoning in a way that helps when a deal requires a novel structure. The IRS FIRPTA page is a useful entry point for buyers and their counsel who see FIRPTA once every few years and want a plain-English refresher on the 15% withholding mechanics under Sec. 1445 before they get to the certifications.
Summary: 2026 FIRPTA and Sec. 892 changes
- The 2025 proposed FIRPTA regulations (REG-109742-25) repeal the lookthrough rule for U.S. corporate shareholders of a REIT. Reliance is permitted for transactions on or after April 24, 2024.
- T.D. 10042 finalizes Sec. 892 regulations — narrower deemed rule, QPI exception, derivatives carve-out, and an inadvertent activity escape.
- REITs remain cautious about issuing DC certifications while the 2025 rules are only proposed; buyers still default to 15% withholding under Sec. 1445 in many deals.
- The five-year DC REIT lookback will straddle the 2024 and 2025 frameworks — testing documentation should reflect which rule applied in each part of the period.
- Sovereign investors have more room to hold U.S. real estate through partnerships without losing Sec. 892 — but aggregation and control tests still require careful analysis.
Frequently asked questions about FIRPTA and the 2026 changes ❓
Q. What is FIRPTA and why does it matter for foreign investors in U.S. real estate?
FIRPTA is the Foreign Investment in Real Property Tax Act. It treats gain from a non-U.S. person’s sale of a U.S. real property interest as effectively connected income, so the seller must file a U.S. federal income tax return and pay tax. Buyers of U.S. real property interests from foreign sellers generally have to withhold 15% of the gross amount under Sec. 1445, which is why FIRPTA touches almost every cross-border real estate deal even when no gain is expected.
Q. What changed for domestically controlled REITs under the 2025 proposed regulations?
The 2025 proposed regulations under Sec. 897 (REG-109742-25) repeal the lookthrough rule that had been imposed on foreign-controlled domestic corporations by the 2024 final regulations (T.D. 9992). Under the new proposal, U.S. corporate shareholders of a REIT are counted as domestic even if they are more than 50% foreign-owned. Taxpayers may rely on the proposed rules for transactions occurring on or after April 24, 2024, and until final regulations are issued.
Q. How does the FIRPTA lookthrough rule repeal affect REIT status determinations?
It removes a significant compliance burden. Under the 2024 rule, a REIT had to inquire about the ultimate ownership of its U.S. corporate shareholders, which is often dynamic. Under the 2025 proposal, the analysis stops at the U.S. corporate shareholder level. A REIT with U.S. corporate shareholders is more likely to qualify as domestically controlled, which is the gateway to non-U.S. shareholders being exempt from FIRPTA on a sale of REIT stock under Sec. 897(h)(2).
Q. What did T.D. 10042 change for foreign governments investing in U.S. real estate?
T.D. 10042 finalized long-pending Sec. 892 regulations. It narrows the deemed commercial activity rule so it only applies to domestic USRPHCs, adds a qualified partnership interest (QPI) exception for noncontrolling partnership interests, treats non-dealer derivatives as financial instruments rather than commercial activity, and introduces an inadvertent commercial activity exception. Sovereign investors and their controlled entities have significantly more room to hold U.S. real estate through partnerships without losing the Sec. 892 exemption on their other income.
Q. Should a REIT still issue a FIRPTA certification while the 2025 rules are only proposed?
It is a judgment call. The reliance provision in the proposed rules lets a REIT treat itself as domestically controlled under the new analysis today, but some REITs are cautious about issuing certifications until the regulations are final. When the certification is not issued, the buyer’s default is to withhold 15% under Sec. 1445(a), and the seller recovers any excess through a filed U.S. return. Sellers and buyers often address the risk contractually with FIRPTA escrow arrangements.
Q. Does the 5% de minimis QPI safe harbor solve every sovereign investment problem?
No. A partnership interest of 5% or less that meets the other requirements is automatically treated as a QPI, so the partnership’s commercial activity is not attributed to the foreign government. But income directly attributable to the partnership’s commercial activity is still not eligible for the Sec. 892 exemption and must be reported. And where a sovereign holds larger interests, or several interests that must be aggregated, the full QPI analysis under the final regulations applies.
This article is general information, not tax or legal advice for your situation. Cross-border real estate structures turn on their facts. If you or your fund is affected by the 2025 proposed FIRPTA regulations or T.D. 10042, contact SW Accounting & Consulting Corp for a confidential review.
