The IRS released a generic legal advice memorandum (GLAM 2023-003) on May 19 addressing the application of the regularly traded stock exception under Section 897(c)(3) to stock of a U.S. real property holding corporation (USRPHC) held by a partnership. The GLAM concluded that the 5% ownership test (10% for real estate investment trusts) should apply at the partnership level under an “entity” level approach and not under an “aggregate” approach at the partner level.
A USRPHC is a domestic corporation whose U.S. real property interests exceed certain thresholds, and a USRPHC can be considered a U.S. real property interest (USRPI) for withholding purposes. Section 897(c)(3) provides an exception to the general definition of a USRPHC for corporations with a class of stock regularly traded on an established securities market. Such stock shall not be treated as a USRPI except for a person who holds more than 5% of the class of stock during the relevant holding period. The GLAM refers to this as the “regularly traded exception.”
The GLAM addresses the application of the regularly traded exception to a nonresident alien (NRA) by walking through two situations in which a partnership owns shares of a USRPHC that has a single class of publicly traded stock for purposes of Section 897(c)(3). Under the examples, an NRA owns a 25% interest in the capital and profits of the partnership while the remaining interest is held by various unrelated U.S. persons.
The first situation provides that the partnership directly owns 8% of the USRPHC stock while NRA does not own any other shares aside from its indirect ownership through the partnership. When the partnership disposes of its shares, the GLAM clarifies that the regularly traded stock exception test applies at the partnership level (i.e., the entity level) so that NRA’s allocable share of the gain is effectively connected income (ECI) despite the partner owning less than 5% indirectly (i.e., if the partnership were treated as an aggregate of its partners, the NRA would only own 25% of 8% or 2%).
In the second situation, the partnership directly owns 4% of the USRPHC stock and the NRA directly owns 4.5%. The GLAM confirms that due to the attribution rules under Section 318, the NRA is considered to own in total 5.5% (4.5% directly plus 1% (25% of the partnership’s 4% interest)). As a result, when the NRA disposes of its shares, the stock is considered USRPI and the NRA’s gain on the disposition is ECI.
Taxpayers investing in publicly traded USRPHCs through partnerships should consider this GLAM when evaluating the application of the regularly traded exception.
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David E. Sites
National Managing Principal, International Tax Services
Grant Thornton Advisors LLC
David leads the firm's International Tax practice, which focuses on global tax planning, cross border merger and acquisition structuring, and working with global organizations in a variety of other international tax areas.
Washington DC, Washington DC
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