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Positive Tax Ruling on Sale of a U.S. Partnership Interest


​​​​​​The U.S. Internal Revenue Service has been of the view for a long time that a foreign person who sells an interest in a partnership earning U.S. business income is subject to U.S. tax on the gain on that sale.1 A recent case held the gain is exempt2 – and this holding could have positive implications on investing in U.S. real estate.

In the recent case, there were two parts to the gain – one related to U.S. real estate and the other to business operations. The gain on the real estate was taxable, under the U.S. Foreign Investment in Real Property Tax Act (FIRPTA).3 That was not really in doubt. But the exemption for the gain on the remainder of the sale was unexpected.

The essence of the decision was that the sale of the business was not U.S.-source income. The Internal Revenue Code does not provide rules for determining the source of this gain.

The sale in question was of units of a limited liability company (LLC). The LLC was treated, as usual, as a partnership for U.S. tax purposes. Nothing in this case turns on the LLC status.

How a Sale of a Partnership Interest is Viewed

There are two competing theories on the sale of partnership interests, both of which are used in the tax system, in different contexts:

  • Entity approach – the partnership interest is an asset that is closely related to the residency of the owner. This is the way sales of shares of corporations are generally viewed.
  • Aggregate approach – the partnership is a pass-through. Activities which take place inside the partnership are attributed to the owners and the actions of the owners are often attributed to the partnership. Income earned by a partnership is not subject to tax in the hands of the partnership, but rather is seen as being earned by the partners. They pay the tax.

The historical IRS view was based on the aggregate approach. The judge decided this using the entity approach – he decided it was a gain from the disposition of personal property. The disposition of personal property by a non-resident is sourced outside the U.S.4 

Judge Critical of IRS’ Reasoning

The judge was quite critical of the IRS, stating that the Revenue Ruling “is not simply an interpretation of the IRS’ own ambiguous regulations… Its treatment of the partnership provisions… is cursory in the extreme…”

The partnership had an office in the United States, but that did not cause the gain to be U.S.-source.

This decision is even stronger because the partnership interest was not sold – the partnership redeemed out the owner. 

One warning – this decision is recent. It could be appealed and overturned.

Estate Tax Implications

For foreigners (U.S. non-resident aliens), the IRS only applies estate and gift tax to U.S.-situs property, like real estate.

A related question – still outstanding – is whether a partnership interest is considered U.S.-situs property for estate and gift tax purposes.5 This is important where a foreign (say, Canadian) partnership owns US real estate. If the partnership interest is separate, then a Canadian decedent partner would be exempt from US estate tax. If a “look-through” rule is applied, the decedent would be taxable. The IRS will not currently rule on this point.6 

There is another case which supports the notion that a partnership interest is an asset separate from the underlying property7– a position which is happily consistent with the income tax decision above.

The combination of decisions adds weight to the strategy of using a foreign partnership to own U.S. real estate. It may protect the partner from U.S. estate and gift tax.

Contact Kevyn Nightingale, CPA, CA (ON), CPA (IL), TEP, Business Advisor, International Tax, at 416.515.3881 or [email protected]


1  Rev Rul 91-32

2  Grecian Magnesite Mining v. Com’r 149 TC No 3 (07/13/2017)

3  IRC §897(g)

4  IRC §865(a)

5  IRC §2501(a)(2)

6  Rev Proc 2016-7 §4.01(29)

7  ​Pierre v CIR 133 TC 24 (2009)​