Introduction
It is not uncommon for a foreigner to invest in real property in the United States.
When a foreigner acquires U.S. real estate, they obtain what are known as U.S. real property interests (USRPIs). Typically, if a foreign individual owns real estate in the U.S., it may trigger the Foreign Investment in Real Property Tax Act (FIRPTA) withholding requirement.
However, foreign shareholders can also own real estate through a U.S. corporation. When a foreign person primarily owns U.S. real estate via a U.S. corporation, that corporation may be classified as a U.S. Real Property Holding Corporation (USRPHC). Therefore, it is crucial for foreign investors to understand the concept of USRPHC.
How Does a Corporation Qualify as a U.S. Real Property Holding Corporation (USRPHC)?
A USRPHC, or United States Real Property Holding Corporation, is a domestic corporation in the U.S. that meets the following criteria:
- Foreign individuals or entities hold shares in U.S. corporations.
- The U.S. corporation primarily holds U.S. real estate as its assets.
- The fair market value of its U.S. real property interests constitutes at least 50% of the total combined fair market value of its worldwide real estate interests and business assets, as defined in 26 U.S. Code §897(c)(2))
In summary, a USRPHC is a U.S. corporation with foreign investors who have an ownership stake in it. The fair market value of U.S. real estate interests must constitute at least half of the corporation’s total fair market value.
For example, let’s consider a U.S. corporation that owns U.S. real property with fair market value of $1,000,000, foreign real property at $800,000, and other business assets at $400,000.
In this case, the corporation’s total worldwide real property and business assets amount to $2,200,000 ($1,000,000 + $800,000 + $400,000). Therefore, 50% of the total fair market value of assets is $1,100,000. Since the fair market value of the U.S. real estate property interests is $1,000,000, which is less than $1,100,000 (50% of the total), the corporation does not qualify as a U.S. Real Property Holding Company (USRPHC).
Now, suppose the U.S. corporation sells $300,000 worth of its foreign business assets, reducing the value of those assets from $400,000 to $100,000. The new total of worldwide real property and business assets would be $1,900,000 ($1,000,000 + $800,000 + $100,000). Fifty percent of $1,900,000 equals $950,000. However, the fair market value of U.S. real property interest is $1,000,000, which is greater than $950,000 (50% of the total). As a result of this sale, the corporation now qualifies as a USRPHC because its fair market value of U.S. real property interests exceeds 50% of its total fair market value of worldwide real and business assets.
The key takeaway is that if a foreign person sells their interest in a USRPHC, any gains from that sale may be subject to U.S. taxation (including income tax and withholding tax consequences).
When does a U.S. Corporation qualify as a USRPHC?
A U.S. corporation qualifies as a U.S. Real Property Holding Corporation (USRPHC) based on the “determination date” test as outlined under 26 CFR § 1.897-2(c)
In general, whether a U.S. corporation is a U.S. real property holding corporation is to be determined as of the following dates:
- The last day of each tax year;
- Any day the company acquires U.S. Real Property Interests (USRPI) or sells foreign property or other business assets, as specified in 26 CFR § 1.897-2(c)
For example, in the above example, if the disposition of an asset worth $300,000 occurred on June 1, 2025, that date would serve as the determination date.
Termination of USRPHC status
Consider a U.S. corporation that was once classified as a USRPHC. This means it primarily held U.S. real estate, with at least 50% of its fair market value of its combined assets being U.S. real estate.
If a corporation sells some of its U.S. real estate and the fair market value of its U.S. real estate falls below 50% of its total assets, it will no longer meet the U.S. Real Property Holding Company (USRPHC) test. However, the corporation will remain classified as a USRPHC for the next five years, unless an exception applies under the early termination rule. (§1.897-2(f)(2))
Conclusion
In summary, the USRPHC rules play a vital role for foreign investors in U.S. real estate, as they greatly influence the tax implications related to the sale of these investments. Therefore, it is essential for foreign investors to understand these rules both before and after investing in U.S. corporations that possess significant real estate assets.
Are you looking for personalized advice on international tax matters related to your U.S. real estate investments? Contact Arora Law P.C. today for an international tax consultation.
Disclaimer: The information provided in this article is for general informational purposes only and does not include legal advice. This article does not comprise an attorney-client relationship between the reader and Arora Law P.C. or its attorneys. If you have specific questions regarding your individual situation, please consult with a licensed attorney.
The information in this article is current as of the publication date. U.S. Tax laws and regulations change frequently, and readers should confirm whether any updates have occurred since.