Internal Revenue Bulletin:  2007-21 

May 21, 2007 

Notice 2007-42

Treatment of Currency Gain That a Real Estate Investment Trust (REIT) Recognizes From a Qualified Business Unit (QBU) of the REIT

Table of Contents

This notice provides guidance with respect to the circumstances under which § 856(c)(2) or § 856(c)(3) characterizes § 987 gain as qualifying income for purposes of REIT qualification.


Under paragraph (3) of § 856(c), at least 75 percent of a REIT’s annual gross income must be derived from the types of income listed in that paragraph, often characterized as income from real estate sources. Under paragraph (2) of § 856(c), at least 95 percent of a REIT’s annual gross income must be derived from the types of income listed in that paragraph, often characterized as income from “passive” sources, including interest and dividends.

The Service is aware that some REITs have invested in real estate assets outside the United States through entities or partnerships that qualify as QBUs, as defined in § 989(a). The Service has explicitly ruled that otherwise-qualifying assets do not fail to satisfy § 856(c)(4) merely because the assets are foreign:

Neither section 856 of the Code nor the regulations thereunder restrict the term “real estate assets” to those located within the United States. Accordingly, it is held that, for purposes of section 856(c), the term “real property” includes land or improvements thereon located outside the United States and the term “mortgages on real property” includes a security interest which, under the laws of the jurisdiction in which the property is located, is the legal equivalent of a mortgage or deed of trust in the United States.

Rev. Rul. 74-191, 1974-1 C.B. 170, 170. It follows from this holding both that rents on foreign real property qualify under § 856(c)(2)-(3) to the same extent that they would qualify if the property were located in the United States, and that interest on foreign mortgage loans qualifies under § 856(c)(2)-(3) to the same extent that it would qualify if the loans were governed by United States law and the property were located in the United States. Thus, foreign situs of a REIT’s assets does not necessarily prevent the REIT from satisfying the income and asset tests of § 856(c), which must be met in order to qualify as a REIT. Rev. Rul. 74-191, however, does not address the treatment of foreign currency gain that may result from investing in real property or other assets through a QBU with a functional currency other than the dollar.

In general, § 985 provides that all determinations for federal income tax purposes are to be made in the taxpayer’s functional currency. Section 985(a). Section 1.985-1(b)(1)(iii) of the Income Tax Regulations provides that, except as otherwise provided by ruling or administrative pronouncement, the U.S. dollar is the functional currency of a QBU that has the United States as its residence, as defined in § 988(a)(3)(B). Section 1.989(a)-1(b)(2)(i) provides that a corporation is a QBU.  Section 988(a)(3)(B)(i)(II) provides that the United States is the residence of a corporation that is a United States person. Section 7701(a)(30) provides, in part, that the term “United States person” includes a domestic corporation. Section 7701(a)(4) provides that the term “domestic,” as applied to a corporation, means created or organized in the United States or under the law of the United States or any State. Thus, absent a ruling to the contrary, a REIT has the dollar as its functional currency because § 856(a)(3) requires it to be taxable as a domestic corporation.

A REIT may have a QBU that is subject to § 987 and that has a functional currency other than the dollar. See § 1.985-1(c). In such a case, a REIT may recognize currency gain under § 987 when the QBU remits property to the REIT. Section 987(3).

Proposed regulations (REG-208270-86, 2006-42 I.R.B. 698 [71 FR 52,876]) under § 987 were issued September 7, 2006. Section 1.987-6(b) of the proposed regulations generally provides that the owner of a § 987 QBU must determine the character of § 987 gain or loss in the year of remittance using the asset method provided in § 1.861-9T(g), as modified by the proposed regulations. The modified gross income method described in § 1.861-9T(j) cannot be used. If finalized as currently proposed, however, the regulations will not apply to REITs. See Prop. Treas. Reg. § 1.987-1(b)(1)(iii). Some REITs have requested guidance concerning the status under § 856(c)(2)-(3) of any foreign currency gain that is recognized under § 987 when a QBU remits property to a REIT.


Because the currency gain from remittances is determined under § 987, the Service believes that it is appropriate for issues that arise in connection with that gain to be addressed under methods similar to those provided in § 987 and the regulations thereunder. The Treasury Department and the Service therefore intend to amend the proposed regulations under § 987 to include guidance concerning the characterization for purposes of § 856(c)(2) and (3) of § 987 gain recognized by a REIT on a remittance from a QBU of the REIT.

Until further guidance is published, if a REIT recognizes § 987 gain, the REIT may apply the principles of the proposed regulations under § 987 issued September 7, 2006 to determine whether that § 987 gain is derived from income that is described in § 856(c)(2)(A) - (H) or § 856(c)(3)(A) - (I).

The principal author of this notice is Jonathan D. Silver of the Office of Associate Chief Counsel (Financial Institutions & Products).  For further information regarding this notice, contact  Jonathan D. Silver at (202) 622-3930 (not a toll-free call).

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