If you are a foreign person (i.e., non-U.S. person) preparing to sell your U.S. real estate and don’t want to be hit with a hefty tax penalty after the transaction, understanding the Foreign Investment in Real Property Tax Act (FIRPTA) is critical.
What is FIRPTA?
This forty-plus-year-old mechanism was designed to help ensure that non-U.S. citizens do not escape paying taxes on income from the sale of U.S. real property. It requires the buyer of real property from a foreign seller to withhold a portion of the sale price and remit the tax to the Internal Revenue Service (IRS). FIRPTA also applies to the sale of U.S. real property held by foreign-owned corporations, partnerships, trusts and estates.
Although the tax charged comes from the sales price, the responsibility to withhold is on the buyer. If the buyer fails to comply with the FIRPTA withholding requirements, then they may be held liable for the tax owed—in addition to penalties and interest. Working with experienced real estate advisors, tax professionals and an attorney who can assist with FIRPTA compliance is crucial – buyers should seek assistance regarding their withholding obligations, and foreign sellers should do the same to help reduce their tax liability or with post-sale U.S. tax compliance.
FIRPTA Withholding
Here are five key considerations for buyers and sellers to be aware of when dealing with FIRPTA Withholding requirements:
1. What to do if FIRPTA applies to you: In general, if you are purchasing an interest in U.S. real property from a person who is not a U.S. citizen or resident, or a company that is not based in the U.S., FIRPTA will apply in most cases. This means that as part of the transaction, it is the buyer’s responsibility—not the seller’s—to withhold 15 percent of the amount realized. In most cases, the closing attorney assists with FIRPTA withholding and compliance. The amount realized is the sum of the cash paid, the fair market value of other property transferred and the amount of any liability assumed by the buyer or to which the property is subject to immediately before and after the transaction.
For example, suppose a foreign person purchased a home in the United States five years ago for $1.5 Million for their children attending college. Right after their children graduate, the foreign person sells the home for $1.2 Million, assuming no other property transferred and no liabilities assumed. Although the property is being sold at a loss, the FIRPTA withholding on the sale of the home is $180,000, unless the foreign seller is able to request a reduced rate of withholding or meet some other withholding exception.
2. Exceptions to FIRPTA: There are certain situations in which the buyer would not have to withhold 15 percent of the purchase price for FIRPTA:
a. If the sale price is $300,000 or less – Properties bought and sold for no more than $300,000 do not require a FIRPTA withholding, as long as the buyer or a member of the buyer’s family intends to live at the property for at least half of the first two years after the purchase. This exception only applies to individual buyers, not companies or investors and requires the buyer to represent their intent to use the property purchased as a residence.
b. If the seller is a U.S. person – FIRPTA only applies to foreign sellers. If the seller can provide legal documentation showing that they are a U.S. citizen or U.S. tax resident, then the sale is not subject to FIRPTA withholding.
c. Complex exemptions – There are several additional exemptions, including non-recognition provisions and provisions that apply based on ownership of foreign common stocks. While they can be advantageous, these exemptions require an intimate understanding of the tax code, and in most cases, the help of an experienced tax and real estate professional.
3. Understand withholding rates: The FIRPTA withholding rate is generally 15 percent of the gross sales price of the U.S. real property being sold, however, it can be adjusted lower in certain circumstances.
For example, If the purchase price is $1 million or less and the property is being acquired as the buyer’s residence the withholding rate is reduced to 10%. Additionally, if the actual capital gains tax liability on the sale is less than 15 percent of the gross sales price, then the buyer can apply for a withholding certificate from the IRS to reduce the amount of actual tax liability. If the foreign seller obtains a withholding certificate from the IRS stating that a lower withholding amount is appropriate, the withholding rate can be reduced to the amount specified in the certificate
4. Compliance: Transactions subject to FIRPTA are required to be reported on Forms 8288 and 8288-A and submitted to the IRS along with the appropriate withholding by the twentieth day after the transaction. A withholding certificate application is filed on Form 8288-B and must be submitted by the date of the transaction. Once the IRS responds, all remaining forms and updated withholding are then required to be submitted by the twentieth day after receiving the IRS response. Further compliance is required by the foreign seller to report the sale either on Form 1040NR (or 1120-F if a foreign corporation).
FIRPTA Withholding Noncompliance Penalties
Penalties for noncompliance: Buyers that fail to withhold FIRPTA tax should expect consequences much like nonpayment of other U.S. taxes, which could potentially be severe. The IRS would likely pursue withholding penalties that include interest on taxes owed, denial of other tax benefits related to the sale, ineligibility for future visas and immigration restrictions as well as legal action.
FIRPTA Withholding Certificate Questionnaire
FIRPTA withholding is an essential consideration for any U.S. property interest transaction that involves a foreign party. If you are considering a transaction in which FIRPTA could apply, having an experienced tax professional on your side could save thousands of dollars on your transaction. Windham Brannon’s team of international tax professionals is well-versed in assisting with the required compliance of FIRPTA withholding. To determine whether your transaction may be subject to reduced withholding, complete our FIRPTA withholding certificate questionnaire, or reach out to Brandi M. Samuel.
