rr-08-31.pdf

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Part I

Section 897.—Disposition of investment in United States real property, 26 CFR 1.897-1:
Taxation of foreign investment in United States real property interests; definition of
terms.

Rev. Rul.2008-31

ISSUE
Is an interest in a notional principal contract, the return on which is calculated by
reference to an index described below referencing data from a geographically and
numerically broad range of United States real estate a United States real property
interest (“USRPI”) under section 897(c)(1) of the Code?
FACTS
X maintains and widely publishes an index (the “Index”) that seeks to measure
the appreciation and depreciation of residential or commercial real estate values within
a metropolitan statistical area (“MSA”), a combined statistical area (“CSA”) (both as
defined by the United States Office of Management and Budget), or a similarly large
geographic area within the United States. The MSA, CSA or similarly large geographic
area has a population exceeding one million people. The Index is calculated by
reference to (1) sales prices (obtained from various public records), (2) appraisals and
reported income, or (3) similar objective financial information, each with respect to a
broad range of real property holdings of unrelated owners within the relevant

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geographic area during a relevant testing period. Using proprietary methods, this
information is weighted, aggregated, and mathematically translated into the Index.
Because of the broad-based nature of the Index, an investor cannot, as a
practical matter, directly or indirectly, own or lease a material percentage of the real
estate, the values of which are reflected by the Index.
On January 1, Year 1, FC, a foreign corporation, enters into a notional principal
contract (“NPC”), within the meaning of sections 1.446-3(c)(1) and 1.863-7(a)(1) of the
Income Tax regulations, with unrelated counterparty DC, a domestic corporation.
Neither FC nor DC is related to X. Pursuant to the NPC, FC profits if the Index
appreciates (that is, to the extent the underlying United States real property in the
particular geographic region appreciates in value) over certain levels. Conversely, FC
suffers a loss if the Index depreciates (or fails to appreciate more than at a specified
rate). During the term of the NPC, DC does not, directly or indirectly, own or lease a
material percentage of the real property, the values of which are reflected by the Index.
LAW
Section 897(a) provides that gain or loss from the disposition of a USRPI of a
nonresident alien individual or a foreign corporation shall be taken into account as
effectively connected income under section 871(b)(1) or section 882(a)(1), respectively,
as if the taxpayer were engaged in a trade or business within the United States during
the taxable year and as if such gain or loss were effectively connected with such trade
or business.

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A USRPI is generally defined under section 897(c)(1)(A) as either an interest in
real property located in the United States or the Virgin Islands, or any interest (other
than an interest solely as a creditor) in any domestic corporation unless the taxpayer
establishes that such corporation was at no time a USRPHC during certain periods.
The term “interest in real property” under section 897(c)(6)(A) includes fee
ownership and co-ownership of land or improvements thereon, leaseholds of land or
improvements thereon, options to acquire land or improvements thereon, and options to
acquire leaseholds of land or improvements thereon.
Section 1.897-1(c)(1) of the regulations generally defines USRPIs to include any
interest, other than an interest solely as a creditor, in real property located in the United
States or the Virgin Islands. Section 1.897-1(d)(2)(i) provides that an interest in real
property other than solely as a creditor includes a fee ownership, co-ownership, or
leasehold interest in real property, a time sharing interest in real property, and a life
estate, remainder, or reversionary interest in such real property. The term also includes
any direct or indirect right to share in the appreciation in the value, or in the gross or net
proceeds or profits generated by, the real property.
HOLDING
Because of the broad-based nature of the Index, the NPC does not represent a
“direct or indirect right to share in the appreciation in the value ... [of] the real property”
within the meaning of Treas. Reg. §1.897-1(d)(2). Accordingly, FC’s interest in the NPC
calculated by reference to the Index is not a USRPI under section 897(c)(1).

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DRAFTING INFORMATION
The principal author of this revenue ruling is Sean W. Mullaney of the Office of
Associate Chief Counsel (International). For further information regarding this revenue
ruling, contact Mr. Mullaney at (202) 622-3860 (not a toll-free call).