U.S. FIRPTA Tax Withholding on Sale of U.S. Real Estate with Foreign Ownership
Ben Kieley, Tax Senior Manager
For anyone who has been through it before, the process of buying/selling a home is not something most people would say they enjoy. It includes countless forms and applications, piles of financial information, and negotiation email chains that seem to never end. It is no wonder that during this process we forget to stop and think, what are the tax consequences of this? In most situations the answer to that is fairly straightforward, yet in a growing number of situations, this may not be the case. Over the past decade, the U.S. has seen an influx of foreigners, individual and institutional, investing in U.S. real estate mainly because favorable exchange rates, historically low interest rates, and a strong market have made the U.S. real estate market very attractive. Buyer (and seller) beware though, as not doing your homework in this area could leave you in a very tough predicament due to the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”).
Before its enactment, it was not uncommon to have a foreign person investing in U.S. real estate, either to live in or to hold for investment. Years later, they would move back to their foreign country, sell the property at an appreciated price, and forgo paying any U.S. tax on the gain. Once overseas, there was little the IRS could do to go after the foreign persons and collect the assessed tax. Congress took it upon itself to address this issue by passing FIRPTA, which placed strict requirements on U.S. real estate transactions involving foreign persons. Specifically, purchasers of U.S. real estate are now required to withhold and remit to the IRS a portion of the sales proceeds, if purchased from a foreign person. Failure to do so could result in the purchaser being liable for the withholding tax.
Pursuant to Internal Revenue Code §1445(a), as amended for the Protecting Americans from Tax Hikes Act of 2015, a purchaser must withhold 15% of the gross sales proceeds paid to a foreign person. This may seem fairly straightforward until trying to determine whether or not the seller is considered a foreign person. Besides a non-resident individual, a “foreign person,” as defined by the IRS, includes corporations, trusts, and partnerships; and requires the purchaser to “look through” to determine who the underlying taxpayers are to determine whether FIRPTA applies. For example, you could have a U.S. LLC owned by five individuals, one of which is foreign. On its face, it may seem that FIRPTA does not apply because it involves a U.S. LLC, but since there is a foreign investor, part of the sale is deemed to involve a foreign person. Once it is determined that foreign persons are involved in the transaction, the next issue involves determining the gross sales proceeds allocated to them, thereby allowing calculation of the correct withholding amount. This may involve the consultation of an attorney or other specialist as some elements, such as LLC agreements, can be quite complex.
As with most things in the tax code, there are certain exceptions available that would exempt the purchaser of the real estate from the withholding requirement. The most common applicable exemptions seen today are as follows:
- Purchaser receives an affidavit under penalties of perjury that seller is not a foreign persons for U.S. tax purposes
- The transaction is considered to be tax-deferred (non-recognition rules) or exempt under an Income Tax Treaty
- The transaction is considered a gift, rather than a sale
- The real estate is intended to be purchaser’s principal residence and price is not in excess of $300,000 (if between $300,000 and $1 million, and used for principal residence, withholding rate is lowered to 10%)
- The purchaser is the U.S. government
- Seller is a U.S. Partnership, Trust, or Estate subject to different withholding rules
Absent any exception or alternative, the purchaser is required to withhold 15% of the gross sales proceeds allocated to the foreign persons. This creates two main issues for foreign persons selling their U.S. real estate. The first being that the withholding tax bears no relation to the actual amount of tax liability recognized on the transaction. In most cases, foreign persons would be paying capital gain rates on the net gain, rather than a tax based on gross proceeds. The difference between these two amounts can be drastic and leads to the second issue of cash flow. Depending on when the transaction occurs, the foreign persons may not be able to utilize the withholdings for months, even though it ultimately will be refunded. For example, if a foreign person enters into a transaction in January and has 15% withheld, the excess withholding will not be refunded until the following year when the tax return is filed and the actual tax is computed. This issue can be mitigated, however, by filing Form 8288-B – Application for Withholding Certificate for Deposition by Foreign Persons of U.S. Real Property Interest. It is important to note that approval is required from the IRS before the purchaser is relieved from the withholding requirement, so given the IRS’s turnaround time, this should be addressed as soon as possible.
As you can see, the rules surrounding just this one area of FIRPTA are quite robust. Taxpayers dealing with these situations can easily find themselves in a difficult position if they lack expertise in the area. Each situation is unique and depends on the facts and circumstances of the specific transaction, but with proper planning taxpayers can avoid these pitfalls.
If you would like to discuss these matters further, please call Stuart Lyons or your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.