Proposed Fractions Rule regulations may help tax-exempt organizations invest in real estate funds

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December 2016

Overview

Proposed regulations recently published under Section 514(c)(9)(E) (the Fractions Rule) are intended to simplify the existing regulations to reflect common business practices in the real estate industry.  The Fractions Rule is important for certain types of tax-exempt organizations that invest in debt-financed real property through partnership structures.

In response to taxpayer comments, the proposed regulations provide additional guidance in determining how the Fractions Rule applies to preferred returns; partner-specific expenses such as management fees; unlikely losses; staged closings, capital commitment defaults; and chargebacks. The proposed regulations also simplify the application of the Fractions Rule to tiered partnerships and add additional de minimis thresholds.

The regulations are proposed to apply to taxable years ending on or after the date final regulations are published in the Federal Register.  However, the preamble states that a partnership and its partners may apply all the rules in these proposed regulations for taxable years ending on or after November 23, 2016.
 
The proposed regulations generally are taxpayer-friendly and include some helpful provisions that address common business practices in the real estate industry.   Still, in some instances, the rules may be viewed as a step backward from prior positions taken by the IRS and additional changes may be desirable so that the final regulations more closely align with common business practices in real estate partnerships.

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Adam Feuerstein

Principal, National Real Estate Tax Technical Leader, PwC US

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