New Section 892 Regulations Impacting Foreign Government Investors and Investment Funds

January 9, 2026 | By: Connie Lee, US Inbounds Tax Leader

On December 15, 2025, the Internal Revenue Service published final and proposed regulations under Section 892 of the Internal Revenue Code (“IRC”) which provides tax exemption to foreign governments on certain investment income. The regulations address when the exemption is unavailable, including when a Section 892 entity is engaged in a commercial activity (“CA”) and when income is received from a controlled commercial entity (“CCE”).

Key Takeaways

The final and proposed regulations introduced many changes that may impact the investment decisions of Section 892 investors.  While some of the new rules are favorable, e.g., the change to the USRPHC per se rule, others may have possibly detrimental effect.  For example, the debt acquisition rules may have lowered the bar for finding a CA to exist.  As discussed below, in some cases, even a single loan may trigger a CA characterization therefore rendering the Section 892 exemption inapplicable.  Section 892 investors and investment funds that raise capital from Section 892 investors are urged to review their investment and fund structures to evaluate the impact of the new rules.

The final and proposed regulations cover a lot of ground not described here. For more information, please contact a member of the Leo Berwick team.

Major Provisions in the Final and Proposed Regulations

The following describes some of the major provisions in the final and proposed regulations.

Final Regulations

USRPHC Per Se Rule Applicable Only to US Corporations

Under prior guidance, any corporation – domestic or foreign – controlled by a Section 892 entity that is a US real property holding corporation (“USRPHC”) will be treated as a per se CCE, and therefore ineligible for the Section 892 exemption.

The final regulations now limit the USRPHC per se rule to US corporations.  As a result, a foreign corporation controlled by a Section 892 entity will not be treated as a CCE solely because its assets were too concentrated in U.S. real estate, including assets in the form of USRPHC stock.

To provide relief for U.S. corporations controlled by Section 892 entities, the final regulations also included a “minority interest” exception.  As a result, a US corporation controlled by a Section 892 entity would nonetheless avoid CCE characterization if it were a USRPHC solely because it holds direct or indirect noncontrolling interest ownership in other corporations.

Definition of Commercial Activity

The final regulations reiterated that CA includes any activity conducted to produce income or gain.  Therefore, an activity that is a trade or business under IRC Sections162 or 864(b) will be viewed as a CA unless an exception is explicitly provided.  Further, even if an activity is not a trade or business, it could nonetheless constitute a CA.

In spite of the broad reach, the final regulations also provided that the mere act of selling a partnership interest (for a Section 892 entity’s own account and other than as a dealer) is not in itself a CA.

Limited Partner Exception

The final regulations modify and finalize a limited partner exception set out in prior proposed regulations.  A foreign government that holds a “qualified partnership interest” will not be considered as engaged in CA solely because it holds an interest in a partnership that engages in a CA.  This rule will not exempt a Section 892 entity’s distributive share of income from any CA conducted by the partnership; however, the CA will not be attributed to the Section 892 controlled entity such that it becomes a CCE and loses its Section 892 exemption with respect to other income.  Generally, the Section 892 entity cannot have a majority interest in or effective control (“EC”) of the partnership.

Proposed Regulations

Debt Acquisition may be a Commercial Activity

The proposed regulations provide that the acquisition of a debt is a CA  – in effect, the activity of loan origination – unless it qualifies as an investment.

To avoid the CA characterization, two safe harbors are provided: (i) debt acquired in a registered offering, and (ii) certain exchange-traded debt instruments not acquired from the issuer or a person under common control and management with the acquiror, provided that acquiror did not participate in the negotiation or issuance of the debt.  Otherwise, the facts and circumstances will need to be examined. A non-exclusive list of factors is included in the proposed regulations.

The proposed regulations included an example of an isolated debt financing as CA.  In that case, the controlled entity of a foreign government negotiated the terms of a debt financing to an unrelated foreign corporation.  Even though all the activities occurred outside of the U.S. and there was only a single loan, the debt acquisition activity is considered a CA upon analyzing of the facts and circumstances.  By contrast, in another example, where the Section 892 entity holds $100 million of equity and $50 million of debt, the IRS concluded that the shareholder loan is an investment.  Taken together, the examples show the determination is highly dependent on the specific facts (if the two safe harbors are not applicable).

Effective Control

CCEs include entities in which a foreign government has EC over such entities.  Under the proposed regulations, effective control includes any interest in the entity that, either separately or in combination, results in control over the operational, managerial, board-level, investor-level decisions of the entity, again looking at the facts and circumstances.  For example, a foreign government will be considered to have effective control over an entity if the foreign government either (i) is, or controls an entity that is, a managing partner or managing member of the entity, or (ii) holds or controls an entity that holds an equivalent role under the entity’s applicable local law.

The proposed regulations contain several examples of this rule.  For instance, even if a Section 892 entity only has a minority interest in a corporation and the ability to appoint only one out of several directors, the Section 892 entity will be considered to have EC if that one director has the sole power to unilaterally appoint or discuss the corporation’s manager.

Applicability Date

The final regulations are generally applicable for tax years beginning on or after December 15, 2025.

The proposed regulations are applicable only for tax years beginning on or after the date they are published in final form.  As a result, the soonest they will be applicable will be 2027 (and possibly in different form).