Here’s an article from Tax Notes Today (warning PDF) about Advice Memorandum 2008-003, written by a tax practitioner. It discusses the technical pushing and shoving on this topic. The article was published in March, 2008.

If you’re a tax law professor, go have fun. For the rest of us, let’s watch a while and see what happens. While you’d think that the IRS would win this fight (when in doubt, impose a tax) I would not underestimate the power of NAREIT.

Just so you have it, here’s the ruling that I think he was referring to. Notice 2007-55.

The IRS is telling the world that it is going to issue regulations to plug what it perceives to be a loophole. Because you don’t want to chase the rabbit’s trail through the Internal Revenue Code, here’s the gist of the problem.

Foreign government investments can be tax-free in many situations. (Section 892 for all of you True Believers who want to read the Holy Bible Internal Revenue Code). Sovereign wealth funds have been buying minority pieces of REITs. Distributions from the REITs are claimed to be tax-exempt because of the exemption for foreign government investments.

The IRS is saying this is bogus.

This is up in the air at the moment. Some commentators have said that the IRS lacks the authority to plug this loophole (if it is one) and the change must come from Congress, if at all.