FIRPTA – Foreign Investment in Real Property Tax Act Explained
Rarely do real estate Buyers include “domestic seller” to the list of must-haves for their realtors to seek out when searching for their dream home. However, real estate Buyers often find themselves having the added responsibility of reporting to the Internal Revenue Service (IRS) when purchasing a property owned by a foreign person or entity due to the Foreign Investment in Real Property Tax Act (hereinafter referred to as “FIRPTA”).
Needless to say, this responsibility causes a lot of confusion and distress amongst Buyers and their agents alike. However, a competent title agent, experienced in handling sales by foreign persons, along with the advice of a qualified accountant and/or attorney, can be extremely helpful in navigating through the process.
The FIRPTA rule was initially enacted in 1980 to ensure that foreign taxpayers pay their income taxes on the sale of real estate they own in the United States. The main purpose of the rule was to impose comparable treatment of foreign and domestic investments in U.S. real property. It requires the withholding of 10-15% of the realized proceeds of the sale of real property owned by a foreign Seller to cover their potential tax liability and avoid them exiting the country and leaving the IRS with no way of collecting.
In transactions involving foreign Sellers, the Buyer is typically considered the “Withholding Agent” and has the responsibility of withholding the potential income tax and depositing it with the IRS. A Buyer is not permitted to assign their responsibility of withholding these funds to anyone else. However, FIRPTA further defines the withholding agent as “any person who represents the transferor or transferee in any negotiation relating to the transaction or in settling the transaction.” Therefore, attorneys or accountants who represent a foreign Seller or Buyer may also find themselves responsible for depositing these withheld funds. Conversely, although escrow and title agents often times issue this payment directly to the IRS as part of their closing services, they cannot be considered the Withholding Agent since they do not represent either party.
Definition of “Foreign Person” for purposes of FIRPTA
Although Buyers are responsible for the withholding and depositing with the IRS, only the foreign persons are subject to the taxation itself. For these purposes, a “foreign person” is defined as a non-resident alien who is not a citizen or legal permanent resident of the United States, or who does not otherwise qualify under the IRS’s “substantial presence test.” This law also applies to foreign corporations, partnerships, trusts or estates that are not otherwise legally formed under U.S. laws.
Those subject to the withholding are required to provide a tax identification number. If the foreign seller does not have a U.S. tax ID number, an ITIN application (form W-7) is required to be submitted along with the requisite withholding forms.
How to Deposit Funds with IRS
The withholding agent is required to submit the payment along with IRS Form 8288-A (U.S. Withholding Tax Return for Disposition by Foreign Persons of U.S. Real Property Interests) and Form 8288-A (Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests) within twenty (20) days of the real estate closing or other disposition of the property.
Calculation of Withheld Amount
The withholding agent must withhold 15% (10% for dispositions before February 17, 2016) of the amount realized from the sale simultaneously with paying the foreign person. As such, it is typically done at closing. Thereafter, the agent’s twenty (20) day timeframe in which to submit such payment to the IRS begins to toll. As added security to ensure that the proceeds are paid, FIRPTA calls for the real property to become the security for the IRS. If the funds are not received, then the IRS has the right to seize the subject property.
The withheld funds are then applied to any taxes that may be owed by the foreign Seller as a result of the sale of the property. If the amount of taxes ultimately due by the foreign Seller is less than the amount withheld, then the Seller may receive a refund.
Definition of Amount Realized
According to the FIRPTA rule, the “Amount Realized” by the Seller is defined as the sum of:
- The cash paid, or to be paid, by the Buyer,
- The fair market value of other property transferred or to be transferred as payment, and
- The amount of any liability assumed by the Buyer or to which the property remains subject to.
However, there are a few occasions in which a foreign Seller can avoid being subject to the withholding. The most common example is in circumstances where the sale of residential property is less than $300,000, FIRPTA allows for the parties to forego submitting the withholding if the Buyer signs an affidavit stating that the property will be used as their personal residence and that it will be occupied by the buyer or buyer’s family at least 50% of the time during the first twenty-four (24) month period after the purchase. Given that the Buyer remains responsible, they may choose not to sign such an affidavit and the withholding must be then submitted.
Additionally, sales of residential property to Buyers who intend to use the property as a personal residence may be subject to a reduced withholding rate of 10% if the amount realized is above $300,000 but less than $1,000,000.
The FIRPTA rules are especially particular and can be very confusing to both Sellers and Buyers alike. As such, it is imperative that the parties to a sale subject to these withholdings are guided by experienced and knowledgeable professionals to assist them with navigating through the process. We at ASR Law Firm are available to assist!