Foreign nationals selling real estate in the United States (and those buying real estate from foreign nationals) must address several unique legal, financial, and tax issues not implicated by transactions between two domestic parties. Most of these issues relate to and arise under a federal law called the Foreign Investment in Real Property Tax Act (FIRPTA). This law imposes obligations on both the seller and buyer regarding the withholding and payment of taxes on capital gains in real estate transactions involving a foreign national seller. Failure to comply with FIRPTA’s withholding requirements can be a costly and disruptive mistake, which is why involving a real estate attorney who has experience with this law is so critical in these types of real estate transactions.
What Is FIRPTA?
When selling real estate in the United States, sellers must pay an income tax to the Internal Revenue Service (IRS) on any capital gains realized from the sale. This is usually simple enough when the seller is a U.S. citizen or national, and is subject to the IRS’s jurisdiction. But when the seller is a citizen of another country, the long arm of the IRS may not be able to reach that far and collect the taxes due.
To address this issue, Congress passed the Foreign Investment in Real Property Tax Act (FIRPTA) in 1980. FIRPTA applies when U.S. property is being sold by a “foreign person” (defined below). The law essentially shifts the obligation to ensure compliance with the seller’s tax liability onto the buyer (though the money ultimately comes from the seller’s pocket). It does so by requiring the buyer to withhold 15% of the gross purchase price and remit it to the IRS within 20 days of the closing of the real estate transaction. The 15% withholding is usually deducted from the seller’s proceeds from the sale.
FIRPTA is a withholding, not a tax, meaning that the amount sent to the IRS may be more or less than the seller’s actual tax liability. The seller is required to file a tax return the year after the sale takes place. When the seller files that tax return, if the FIRPTA withholding amount is greater than the seller’s actual tax liability, the difference will be refunded to the seller. If the FIRPTA withholding is less than what the seller owes to the IRS, the seller must pay the difference upon filing the return. However, not all transactions involving a foreign national seller are subject to this requirement, as discussed below.
What Types of Transactions Are Covered by FIRPTA?
The threshold question to determining if FIRPTA applies to a transaction is whether the seller is a “foreign person” as defined by the IRS. Generally, the IRS defines a “foreign person” as an individual nonresident alien, a foreign corporation not treated as a domestic corporation, or a foreign partnership, estate, or trust.
A nonresident alien is an individual who is not a U.S. citizen or a resident alien. A resident alien is person that is not a citizen or national of the U.S., but they meet either the green card test or the substantial presence test for the calendar year. A resident alien individual, including a nonresident alien electing to be treated as a U.S. resident, is not considered a foreign person. There are several nuances to making this determination which an experienced FIRPTA lawyer can assist with.
Even if the seller is a foreign person, not all real estate transactions are subject to FIRPTA. There are many exemptions to FIRPTA’s withholding requirements, including transactions in which the buyer acquires the property for use as a personal residence and the amount realized by the seller (the sale price) is not more than $300,000. In this scenario, if the buyer signs the personal residence affidavit, the FIRPTA withholding is reduced to zero. To meet this exception, the buyer must certify that they (or an immediate member of their family) intend to use the property as their residence for more than 50% of the days the property is used by any person during the first two 12-month periods after the sale.
If the amount realized (typically the sale price) is $300,000 to $1 million and the buyer signs the personal residence affidavit, FIRPTA is withheld at a rate of 10%. If the sale price is more than $1 million, the FIRPTA withholding is at the regular rate of 15% of the gross purchase price. Note, the personal residence exemption cannot be taken advantage of if the buyer is a corporate entity, such as a limited liability company or corporation.
What Does a Buyer Have To Do To Satisfy Their FIRPTA Withholding Obligations?
In most transactions covered by FIRPTA, the buyer must withhold 15% of the gross purchase price. For example, if the purchase price is $500,000, the withholding amount would be $75,000. If the buyer signs the personal residence affidavit (as discussed above), the 15% FIRPTA withholding would be reduced to 10%, or $50,000.
Often, the buyer’s attorney or the title company involved in the transaction will act as the withholding agent and hold the funds in escrow. In addition to withholding, the buyer or their agent in most cases must remit the withheld amount to the IRS within 20 days of closing.
However, reductions can apply and be sought by the seller in certain circumstances. For example, if the amount of withholding exceeds the seller’s actual tax liability, the seller can file to receive a refund. The seller can also file for a FIRPTA withholding certificate, as discussed below.
How Does a Foreign Seller Obtain Amounts Withheld Under FIRPTA?
The FIRPTA withholding rarely equals the actual amount of tax the seller owes upon sale. Often, it more than the seller’s actual tax liability, especially when the property is sold for a loss.
Foreign sellers will not see any of the withheld funds until they file a U.S. tax return. After the IRS receives the withheld funds, it sends proof of the withholding (Form 8288-A) to the foreign seller, which they then attach to their tax return filing. The IRS will refund the difference if the tax owed is less than the FIRPTA withholding.
Alternatively, the seller can file a Certificate of Withholding (Form 8288-B) with the IRS on or prior to the closing date requesting a reduction or elimination of the FIRPTA withholding (the FIRPTA 8288-B withholding package requires certain attachments and calculations to be provided as supporting evidence). In this case, the FIRPTA withholding check is not mailed to the IRS; rather, it is held in escrow pending the IRS’s determination. The IRS then issues a withholding certificate letter approving either a reduction or elimination of the FIRPTA withholding. At this point, the withholding agent (usually the title company or buyer’s attorney) can release the FIRPTA withholding to the foreign seller as per the terms of the IRS withholding certificate.
The foregoing only scratches the surface of FIRPTA. Several nuances in the law and the specifics of a given transaction make it imperative that both the buyer and seller work with an experienced FIRPTA real estate attorney to ensure that all legal obligations are satisfied.
At Farshchian Law, we work with individuals and companies from around the world who are involved in U.S. real estate transactions. We provide FIRPTA services for properties that are being sold anywhere in the United States. Please call us at (305) 901-5628 or (239) 935-8599 or email us at Info@JFRealEstateLaw.com to learn more about how we can help you.