The Foreign Investment in Real Property Tax Act, also known as FIRPTA, is a tax act that has been around since the 1980’s. This act is designed for the government to protect property interests in the United States, therefore regulating foreign investments in US property.
The act is designed to regulate foreign investments in US Real Property Interests (USRPI). We first need to know what US Property is. The IRS explains USRPI as interests that a taxpayer has in real property located in the United States or in the US Virgin Islands as well as certain personal property that is associated with the use of the real property. The term interests includes having shares in a domestic corporation which hold any USRPIs unless the corporation was not a US real property holding company (USRPHC).
The second point to keep in mind is that the act regulates foreign investments on USRPIs defined above. This means that FIRPTA withholding applies to foreign taxpayers (sellers) who dispose of US Real Property Interests (USRPI). Taxpayers who purchase USRPI from foreign taxpayers are required to withhold, starting from February 17, 2016, 15% of the gross proceeds (amount realized) on the disposition. This means that the rate of withholding is applied to the cash being paid, the fair market value of any other property being transferred, and the amount of any liability assumed by the purchaser or which the property is subject to immediately before or after the transfer.
Depending on the type of ownership of a USRPI, different withholding regulations might apply and therefore not limited to the 15% withholding on gross proceeds. The following are some examples of ownership types and withholding requirements:
1) Jointly owned properties, by U.S. and foreign persons, will have the amount realized allocated depending on the capital contributions of each.
2) Foreign corporations will withhold 35% of the gain it recognized on its distribution to shareholders.
3) Domestic Corporations will withhold tax on the fair market value of the property distributed if the corporation is a USRPI and the property distributed is either in the redemption of stock or in a liquidation.
Even though there are various regulations concerning FIRPTA, when it comes to withholding and ownership structures, it is important to realize that withholding taxes on the amount realized is a heavy burden for any foreign taxpayer attempting to sell. This is the case since the taxpayer would have to wait to file a tax return to claim a refund for excess withholding. There are various possibilities to be able to avoid this withholding which includes, but are not limited to:
1) Acquiring a residence that is less than $300,000 where you or a family member live in the residence for 50% of the time in two years broken down into two 12 month segments.
2) If you are disposing your interests in a corporation and that corporation certifies it is not a USRPI where the corporation was not a USRPCH in the last 5 years or it is not considered a USRPI by law.
3) You receive a withholding certificate from the Internal Revenue Service.
Method number three is one of the most frequently used ways to reduce or avoid the FIRPTA withholding. The reasons where this withholding certificate might be issued is if the IRS determines that the amount withheld if greater than the tax liability the seller will incur, the seller is exempt from US tax of all of the gain realized or an agreement with the IRS where security for the tax liability is provided by either the transferee or the transferor. It is important to make sure that a complete application, Form 8288-B, is made before or on the date of the transfer, otherwise, the application would be rejected. Within 90 days of filing, the IRS will then issue the withholding certificate.
Once the seller has applied for the withholding certificate, the IRS will delay the collection and reporting of the tax, under Form 8288-A, by 20 days starting from the date on which it has issued the withholding certificate whether it is approved or denied. Please note that to avoid any penalties or interests, even though you have applied for the withholding certificate, the full amount of the withholding tax has to be held in an escrow account until the certificate is received. The advantage of this is that the seller will receive the money as soon as the certificate, instead of waiting to file a tax return. The buyer will also be certain that he will not incur any future tax liabilities or penalties.
Selling or buying real estate can be quite risky and confusing unless proper guidance is received by your real estate agent, attorney, and CPA. We are available to help you plan your real estate transactions so that you can comply with IRS regulations and reduce your tax risk. Please call us for more details.