On October 20, 2025, the IRS and Treasury Department issued proposed regulations (REG-109742-25) that would remove the "domestic corporation look-through rule" for determining domestic control of a qualified investment entity (QIE). Accordingly, under the proposed regulations, all domestic C corporations would be treated as non-look-through persons for purposes of determining whether a QIE is domestically controlled within the meaning of IRC Section 897(h)(4)(B).

The domestic corporation look-through rule was finalized as part of regulations issued in April 2024 that provided guidance on when QIEs, meaning real estate investment trusts (REITs) and certain regulated investment companies (RICs), are considered domestically controlled for purposes of the Foreign Investment in Real Property Tax Act (FIRPTA) rules (see Tax Alert 2024-0885).

The proposed regulations, when finalized, would apply to transactions occurring on or after October 20, 2025. Additionally, taxpayers may rely on the proposed regulations for transactions occurring before the date the proposed regulations are finalized. Thus, there is no period of time for which taxpayers are required to apply the domestic corporation look-through rule.

Background

Under IRC Section 897, gain derived by a nonresident alien or foreign corporation from the sale or other disposition of a US real property interest (USRPI) is taxed as US-sourced income effectively connected with a US trade or business. Under IRC Sections 897(h)(2) and (h)(4)(B), a USRPI excludes any interest in a QIE that is domestically controlled (the domestically controlled QIE exception). A QIE is considered domestically controlled if less than 50% of the value of its stock is held, directly or indirectly, by foreign persons at all times during a lookback "testing period" that is the shorter of: (1) the five-year period ending on the date of disposition or distribution, as the case may be, or (2) the period of the QIE's existence.

The phrase "held directly or indirectly" is not defined in the statute. IRC Section 897(h)(4)(E) provides limited rules for classifying holders of QIE stock as US or foreign entities. A QIE shareholder that is itself a QIE is treated as a foreign person in certain circumstances. IRC Section 897(h)(4)(E) also treats QIE stock held by another publicly traded QIE as held by a foreign or US person based on whether the QIE is domestically controlled. Additionally, IRC Section 897(h)(4)(E) treats QIE stock owned by another privately held QIE, as held by a US person only in proportion to the stock of the other QIE held by a US person.

Proposed regulations issued at the end of 2022 introduced "general" and "special" look-through rules to determine whether a QIE's stock is "indirectly" held by foreign persons for purposes of the domestically controlled QIE exception (see Tax Alert 2023-0059). The special look-through rules included a "domestic corporation look-through rule" that would have treated certain non-public domestic C corporations as look-through persons if 25% or more of the fair market value (FMV) of the corporation's outstanding stock were held, directly or indirectly, by foreign persons.

In April 2024, Treasury and the IRS issued final regulations that increased the foreign ownership threshold for the domestic corporation look-through rule to more than 50% (rather than 25% or more) of the FMV of the corporation's outstanding stock. The final regulations also contain a 10-year transition rule that exempts existing QIEs from the domestic corporation look-through rule, contingent upon continuously meeting certain stringent requirements.

New proposed regulations

According to the Preamble of the proposed regulations, Treasury and the IRS received feedback recommending the withdrawal of the domestic corporation look-through rule. The feedback focused on the practical difficulties of tracing upstream ownership, as well as legal uncertainties and operational complexities. Commentators also argued that the rule is inconsistent with the statute and congressional intent, as IRC Section 897(h)(4)(B) does not contain look-through rules, whereas other provisions of IRC Section 897 (most notably IRC Section 897(h)(4)(E)) do contain look-through rules, but not any rule similar to the domestic corporation look-through rule. Therefore, commentators said, the absence of a domestic corporation look-through rule or similar rule in IRC Section 897(h)(4)(B) was intentional. Taxpayers also argued that because a domestic C corporation is subject to corporate income tax on gain from a disposition of a USRPI, the goal of IRC Section 897 is met without the need to look through the domestic corporation.

In response to this feedback, Treasury and the IRS concluded that the domestic corporation look-through rule is not an appropriate construction of "indirectly" in IRC Section 897(h)(4)(B).

Accordingly, the proposed regulations would remove the domestic corporation look-through rule and treat all domestic C corporations as non-look-through persons in determining whether a QIE is domestically controlled.

Implications

The withdrawal of the domestic corporation look-through rule would treat domestic C corporations as US persons to determine domestically controlled QIE status. While this withdrawal would be a welcome development for taxpayers, taxpayers who are in the process of, or who were considering, unwinding existing investment structures in light of the final regulations should carefully consider their options.