United States

Real estate fund sponsors: New fractions rule guidance may be coming


A long-awaited Treasury regulations project focusing on the fractions rule is reportedly underway. At its core, the fractions rule aims to prevent the shifting of losses to taxable entities (or the shifting of income to tax-exempt entities) when they co-invest in real estate assets through partnership structures. While neither Treasury nor IRS officials have provided any insight regarding the timing or content of the new guidance, they have confirmed that the project is indeed in the pipeline.

This should come as welcome news for real estate fund sponsors.

Certain qualified tax-exempt organizations, namely pension plans and college endowments, often deploy significant capital to real estate funds. For real estate funds with qualified organizations as investors, the fractions rule has long-served as a popular tax structuring technique by helping to mitigate the qualified organization’s exposure to the unrelated business income tax.

Potential changes stemming from this project may ease the burdens created by the existing rules and could significantly affect high-level tax structuring decisions made by fund sponsors. The decision of whether to employ a fractions rule structure, as opposed to a structure that utilizes a real estate investment trust or other corporate blocker, not only impacts the fund itself, but can have a trickle-down effect on a fund's underlying investments and joint venture partners.

For now, fund sponsors should continue to evaluate the potential viability of a fractions rule structure and monitor the development of guidance that may make this type of structure more appealing to employ and less burdensome with respect to compliance.

John Luksis

Senior Manager

John provides comprehensive tax services to real estate funds, REITs and their affiliates. Contact him at john.luksis@rsmus.com.

Areas of focus: Real EstateFederal TaxPartnership Tax Planning