FIRPTA And The Foreign Investor

UNDERSTANDING FIRPTA

One of the biggest misunderstandings is that FIRPTA is a 15% tax imposed upon foreign sellers when they dispose of their real estate interests. In fact, many times (whenever a profit is not realized) there is no tax at all, instead, FIRPTA is simply a withholding procedure to determine if any taxes are due.

ORIGIN AND HISTORY

FIRPTA is an acronym for the Foreign Investment in Real Property Tax Act of 1980. It is a United States tax law that imposes a tax upon the gain of foreign persons disposing of United States real property interests. It supersedes all tax treaties that might otherwise provide an exemption from tax on such gains.

Prior to its application which took effect in 1981 foreign sellers were often exempt from U.S. tax on profits received from the sale of real estate. The purpose of FIRPTA is to assure that capital gain, if any, is paid before funds can be removed outside the taxing jurisdiction of the United States. As a matter of law, 15% of the gross sales price must be withheld by the purchaser of property acquired from a foreign person, unless there is an exemption from the tax. When applicable, FIRPTA withholding tax is paid directly to the I.R.S. within 20 days of the real estate transfer unless exemptions apply or a withholding certificate is applied for prior to or up until the date of closing.

For US Citizens, the present capital gain rate ranges from 15% to 20% of the net proceeds realized upon sale. Additionally, there is a health care surtax of 3.8% for certain high-income levels creating an effective rate of 18.8% to 23.8%. However, the individual rate for the foreign nationals’ effective rate is a flat 20%. All of the initial acquisition costs together with any capital improvements are totaled to create the “basis”. All expenses of sale are subtracted to determine the net proceeds. If the net proceeds are greater than the basis Sellers will be taxed on the profit in the United States. This tax rate for foreign sellers is 20% if the property is held individually or held in a Land Trust. Foreign corporations are taxed slightly higher at 21%.

TAX IDENTIFICATION NUMBER REQUIREMENT

Foreign Buyers and Sellers of U.S. real property interests are required to obtain an Identification Number to request reduced tax withholding when disposing of the properties interest and to pay any required withholding.
The process for applying for an ITIN is as follows:

1. A W-7 application needs to be completed by the foreign person, Seller, or Buyer together with a certified copy of their passport attached. The passport must be certified by the issuing passport office or the foreign person may submit their original passport which will be returned to them by the IRS.
2. If a foreign Seller is requesting a reduced Withholding Certificate the W-7 application together with a certified passport can be sent to the IRS with the Application for Reduced Withholding (8288B). It can take a minimum of 90 days for the IRS to respond to a request for a reduced withholding amount.
3. If a foreign Seller is submitting the 10% withholding and the foreign Seller does not have an ITIN the Seller must submit the 10% with a form 8289 and 8288A to the IRS in Ogden, Utah. In a separate package, the Seller must submit the completed W-7 with the certified copy of their passport and a copy of the 8288A to Austin, Texas for processing.

MANDATORY FIRPTA COMPLIANCE

There are serious repercussions for failing to comply with FIRPTA. The IRS has defined a withholding agent to be any person in whatever capacity that has control, receipt custody, disposal, or payment of funds that are subject to withholding. Leasing agents must withhold 30% of the gross rental income. As a result, buyers, settlement agents, and leasing agents can be liable for the full 15% or 30% respectively, together with penalties and interest for failure to strictly comply with the applicable withholding requirements. In short, FIRPTA is a far-reaching tax act and anyone dealing with a foreign seller or foreign seller or foreign landlord is put in charge of policing and enforcing the law for the IRS.

EXCEPTIONS

There are noteworthy exceptions for remitting 15% of sales proceeds or 30%
of gross rental income to the I.R.S.

1. SELLING A RESIDENCE FOR $300,000.00 OR LESS

   If a foreign person sells a U.S. residence for $300,000.00 or less and the purchaser intends to occupy the property for residential purposes (although not necessarily the buyer’s principal residence). The sale is exempt from FIRPTA withholding. For purposes of clarification, this exception will apply even if the Buyer only uses the property for 30 days a year, provided he does not intend to rent for more than 30 days. Nonetheless, the Seller must report the sale to the I.R.S. and be responsible for taxes that may be due. Note: If the property being sold is greater than $300,000 but less than 1 million dollars, the 15% withholding amount may be reduced to 10% if the buyer signs a residential use affidavit.

2. 1031 LIKE KIND EXCHANGE

   If the property is being transferred in exchange for another U.S. property then the transaction may qualify for an exemption from FIRPTA as a non-recognition transaction. However, the foreign seller must designate the new property to be purchased within 20 days of the closing (as opposed to 45 days for U.S. Citizens). NOTE: Although this is beneficial to most foreign sellers, it does not benefit Canadians as Canada Revenue Agency does not recognize 1031 Exchanges and the full tax will be due in Canada following the sale.

3. WITHHOLDING CERTIFICATE FOR REDUCTION OR EXEMPTION

   With the present capital gain rate of 20% most often the foreign seller’s FIRPTA tax liability will be less than the amount required to be withheld. A foreign seller may apply for a reduction in the amount to be withheld pursuant to the withholding certificate procedure. Since the I.R.S. has 90 days to respond to such an application, the request should be submitted as early as possible prior to closing to utilize this special escrow procedure. Under this procedure, the withholding tax is not required to be submitted to the I.R.S. within 20 days of closing but rather it can be retained by the closing agent and disbursed immediately upon obtaining a withholding certificate or letter of reduction rather than applying for and obtaining a refund from the I.R.S. Our office is extremely well versed in this process and can handle the procedure without the need to engage third parties.

4. RENTAL INCOME

   When foreign investors rent out their Florida real estate they are subject to a withholding tax of 30% of the gross amount of rental income. Foreign individuals and foreign corporations may elect to have their passive rental income taxed as if it were connected to a U.S. trade or business. One way for foreign investors to avoid the 30% gross withholding tax is to apply for U.S. Tax Identification Number and submit Form W-8ECI, Certificate of Foreign Person’s Claim for Exemption from Withholding on income effectively connected with a trade or business in the United States. Once the election is made by attaching a declaration to a timely filed income tax return, there is no obligation for a rental agent to withhold any funds.

USE OF RESIDENTIAL USE AFFIDAVIT

As mentioned above, an exclusion to FIRPTA withholding may be made if the sales price is under $300,000 and the buyer intends to utilize the property more often than it will be rented out during the first two years of ownership. This will also reduce the amount of withholding on residences from 15% to 10% on sales between $300,000 and 1 million.

A common misunderstanding is that this must be the buyer's principal residence in order to sign the residential use affidavit. That is not the case. The buyer need only intend to reside in the property more often than it is rented. The buyer is not required to be a U.S. citizen or resident however cannot be a corporation, limited liability company or partnership.