FIRPTA stands for Foreign Investment in Real Property Tax Act. The Act came into effect in 1980 to ensure that the U.S. government could collect taxes from foreign persons on the sale of U.S. real property interests.
Since domestic persons were already subject to income tax on the disposition of U.S. real property interests, FIRPTA leveled the playing field between domestic and foreign persons and provided a mechanism which requires that an investor should withhold and remit to the IRS a percentage of the total sales price in anticipation of the taxes that will be due from the foreign seller on this type of transaction. This includes but is not limited to a sale or exchange, liquidation, redemption, gift, transfers, etc.
The amount realized is the sum of the following:
- the cash paid, or to be paid (principal only)
- the fair market value of other property which is transferred or is yet to be transferred
- the amount of any liability assumed by the transferee or to which the given property is subject immediately prior to and after the transfer
FIRPTA applies in almost all transactions, both residential and commercial, whereby a foreign person who owns a U.S. real property interest sells such interest. It is important to keep in mind that the amount withheld is not the tax itself but a payment made on account of the taxes that eventually will be due from the seller.
What is the withholding amount?
FIRPTA requires that the buyer should withhold 15% of the gross sales price (10% for dispositions before February 16, 2016) for any transaction in which a ‘Foreign Person’ sells a U.S. real property interest. However, there are exemptions to this rule (see question 5).
Who is a ‘Foreign Person’?
In order to clearly understand who a ‘Foreign Person’ is, it is crucial to keep in mind the following FIRPTA definitions:
a. A ‘Foreign Person’ is anyone who is not a ‘United States Person’.
b. A ‘United States Person’ is defined as any of the following entities:
- a U.S. citizen
- a resident alien having acquired a Green Card
- a resident alien who meets the Substantial Presence test
- a U.S. corporation, partnership, or other legal entity (except a ‘Disregarded Entity’ as defined by IRS Regulations), trustee, or other fiduciary
- a Disregarded Entity, in case its owner qualifies as a ‘United States Person’ under the previous conditions, or
- a foreign entity that has officially chosen to be treated as a U.S. (domestic) corporation (as evidenced by acknowledgment copy of IRS-furnished election)
c. The Substantial Presence Test.
If you meet the substantial presence test for the calendar year, you will be considered a U.S. resident for tax purposes. To be considered a U.S. Person, you need to be present in the United States for at least:
I. 31 days during the year of sale, and
II. 183 days during the 3-year period which includes the current year and the 2 years immediately preceding the current year, counting:
- all of the days you were present in the United States during the current year, and
- 1/3 of the days you were present during the first year before the current year, and
- 1/6 of the days you were present during the second year before the current year
However, under FIRPTA, certain days may not be included. These are the days when a Foreign Person is present in the United States as:
- a foreign government representative
- a teacher or student under a J, Q, F, or M Visa
- a professional athlete participating in a charitable sports event
d. A ‘Disregarded Entity’ is any domestic business entity with a single owner (e.g. a single-member LLC) other than a corporation that is not recognized for tax purposes as an entity separate from its owner, in case the entity has not elected to be treated as a U.S. (domestic) association for tax purposes.
What happens if the seller is a domestic limited liability company?
A single-member domestic LLC is considered to be a ‘Disregarded Entity’ for tax purposes even though it is a recognized legal entity. Therefore, in case the seller is a single-member LLC, the company’s status will depend on the identity of its only member/owner.
If the sole member of the LLC is a ‘Foreign Person’, the FIRPTA rules on withholding will apply under the same conditions as if the foreign sole member was the seller.
On the other hand, a multi-member LLC is not considered to be a ‘Disregarded Entity’ and accordingly, it is taxed under different conditions as compared to single-member limited liability companies. Therefore, the FIRPTA withholding rules do not pertain to multi-member domestic LLCs.
Are there any exceptions to the withholding requirements?
Yes, there are a number of exceptions to FIRPTA withholding requirements. They can reduce or completely eliminate the required withholding. Under FIRPTA, you do not have to withhold in the following situations but still need to meet notification requirements:
a. The most common and logical exception is when the seller is not a ‘Foreign Person’. In this case, the seller needs to provide the buyer with an affidavit certifying that the seller is not a Foreign Person and providing the following information about the seller:
- U.S. social security number (SSN) or taxpayer identification number (TIN)
- physical address
b. Another exception applies when the transferee purchases the property for use as a residence and the amount realized (sales price) is lower than or equal to $300,000. If this is the case, either you or a member of your family must reside at the property for a minimum of 50% of days this property is used by anyone during each of the first two 12-month periods after the transfer date.
To meet requirements for this exception, the transferee must be an individual, the days the property will be vacant are not to be counted toward the total number of days, and the buyer needs to elect to waive withholding.
c. As of February 16, 2016, a reduced withholding equal to 10% of the sales price is due in the following cases:
- the buyer is purchasing property that will be used as their residence
- the sales price is between $300,000 and $1,000,000
- the buyer elects to waive withholding
In this case, either the buyer or a family member must reside at the property for a minimum of 50% of days this property is used by anyone during each of the first two 12-month periods after the transfer date.
d. The property disposed of is an interest in a U.S. (domestic) corporation in case any class of corporation stock is traded on an established securities market on a regular basis. This exception does not apply to certain dispositions of substantial amounts of interests which are not traded publicly in otherwise publicly traded corporations.
e. If the seller obtains a withholding certificate from the IRS which either reduces or completely eliminates the withholding requirement on the grounds that the interest is not a U.S. real property. In this case, the buyer must obtain a copy of the Withholding Certificate and retain it in their records for at least 5 years.
f. In case a foreign corporation or a single-member LLC subject to FIRPTA withholding has ‘checked the box’ on the applicable IRS form to be taxed as a domestic entity, the corporation or LLC are exempt from withholding. Since domestic corporations are not subject to the withholding rules under FIRPTA, withholding requirements do not pertain to entities which have elected to be taxed as a domestic corporation.
However, to fully comply with the regulations, the entity must:
- fill out Form 8332 with the IRS
- obtain an IRS approval
- provide evidence of this status to the buyer
In addition, the buyer is required to retain a copy of the approval in their record for at least 5 years.
Are all parties required to have TINs?
According to the IRS regulations, when disposing of a U.S. real property interest, all buyers and foreign sellers of U.S. real property are required to provide the following information/documents:
- tax identification number (TIN)
- address on withholding tax return
- application for a withholding certificate
- notice of non-recognition
- other related IRS documents
I. In case the buyer does not have a TIN, they are required to remit the proper withholding forms within 20 days after closing.
In addition, the buyer must also remit a properly completed application (Form W-7) for a TIN at the same time when remitting the withholding forms. However, they need to send this application to a separate address in a separate package. For further information and mailing addresses, you can refer to the instructions for each form.
II. On the other hand, should the seller not have a TIN, the buyer is required to remit the proper withholding forms within 20 days after closing. In this case, the seller’s TIN information will be left blank. It should be noted that even though the TIN is not necessary for closing, the IRS requires that the seller should obtain a TIN in order to be able to process the funds.
In addition, having received the withholding information, the IRS will immediately instruct the seller to apply for a TIN. For this exact reason, a number of settlement agents advise sellers to submit a separate TIN application by the time of closing.
For additional information, please refer to the IRS publication ‘ITIN Guidance for Foreign Property Buyers/Sellers’ available at www.irs.gov.
What happens in case of short sale or insufficient proceeds for withholding?
On certain occasions, such as in case of short sales, the proceeds from the sale do not meet the withholding requirements under FIRPTA. Still, considering that these requirements are not based on the seller’s proceeds but on the sales price itself, no automatic exemption applies for transactions whereby the seller is receiving no or insufficient proceeds.
Should that be the case, the seller needs to apply for an exemption or reduced withholding from the IRS. It is important to note that this process can be time-consuming, so settlement agents are advised to bring up such issues with the foreign seller at the beginning rather than at the end of the process.
What if not all of the sellers are ‘Foreign Persons’?
Whether the buyer must withhold funds under FIRPTA is decided with respect to each seller separately. This pertains even to cases when the seller is a married couple. In general, each Foreign Person is required to withhold a certain percentage based on their share in ownership.
For instance, in the case of four joint owners owning a 25% interest each, where one of the sellers is a Foreign Person, the buyer must withhold only 25% of the required withholding.
Likewise, if the seller of the real property is a married couple, the IRS deems each spouse to own 50%. If only one of the spouses is a Foreign Person, only their half of interest is eligible for withholding.
Who is responsible for complying with FIRPTA?
When buying U.S. real property from a ‘Foreign Person’, the buyer must withhold the appropriate percentage of the gross sales price even though it is the seller who is subjected to tax.
Should the buyer not withhold in a proper manner, they may be liable to the IRS in an amount that is equal to the tax amount that was supposed to be withheld. In addition, they may be required to pay interest and penalties.
Even though the buyer is ultimately liable to the IRS, the settlement agent is responsible and potentially liable for the collection and disbursement of funds to the IRS in case the matter is not handled and documented in a proper manner.
Therefore, if the withheld percentage is anything other than 15% of the sales price, the file needs to reflect a specific written direction from the buyer.
In other words, in case a buyer waives the withholding or withholds a reduced rate, the settlement agent needs to obtain an affidavit from the buyer which clearly states this fact.
In addition, the agent should obtain the information entitling the buyer to the exemption or reduced rate, as well as an acknowledgment stating that the buyer has an opportunity to obtain independent tax or legal advice, if applicable.
How is the withholding submitted and reported?
In general, within 20 days of the closing date, the funds withheld are to be forwarded along with IRS Forms 8288 and 8288-A to the IRS. Nonetheless, the correct withholding tax is to be withheld but does not have to be reported and paid immediately in case an application for a withholding certificate is submitted to the IRS prior to the date of a sale and is still pending with the IRS on the closing date.
It should be noted that the withheld amount (or a lower amount as determined by the IRS) has to be reported and paid within 20 days of the day on which the IRS mails a copy of the withholding certificate or notice of denial.
Do you have more questions?
For further questions, feel free to contact a First American underwriter. Nonetheless, it is important to understand that First American cannot provide legal advice regarding FIRPTA. This article should be regarded as informational only. In case any party needs legal advice, their settlement agent should advise them to seek legal counsel.