FIRPTA – Withholding of Tax on Dispositions of United States Real Property Interests
Among the many documents which are presented and processed during escrow is a certificate of non-foreign status. The reason for this document is to protect the property buyer from liability for the IRS withholding tax which applies if the seller is a foreign person. If the Seller is a US Citizen or a US Resident then FIRPTA does not apply. If the Seller is not a US Citizen or a US Resident then the Buyer may have to withhold 10% of the sale price at the closing. Although the taxable gain of a transaction is earned by and thus taxable to the foreign seller, the buyer is held liable for the tax if it is not paid by the foreign seller. When is the last time you encountered a transaction with a foreign seller? Foreign seller’s are coming to Miami and here is some information on FIRPTA.
The disposition of a U.S. real property interest by a foreign person (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. FIRPTA authorized the United States to tax foreign persons on dispositions of U.S. real property interests. A disposition means “disposition” for any purpose of the Internal Revenue Code. This includes but is not limited to a sale or exchange, liquidation, redemption, gift, transfers, etc. Persons purchasing U.S. real property interests (transferees) from foreign persons, certain purchasers’ agents, and settlement officers are required to withhold 10 percent of the amount realized on the disposition (special rules for foreign corporations). In most cases, the transferee/buyer is the withholding agent. If you are the transferee/buyer you must find out if the transferor is a foreign person. If the transferor is a foreign person and you fail to withhold, you may be held liable for the tax. For cases in which a U.S. business entity such as a corporation or partnership disposes of a U.S. real property interest, the business entity itself is the withholding agent.
U.S. Real Property Interest
A U.S. real property interest is any interest, other than solely as a creditor, in real property (including an interest in a mine, well, or other natural deposit) located in the United States or the U.S. Virgin Islands, as well as certain personal property that is associated with the use of real property (such as farming machinery or hotel furniture). It also means any interest, other than solely as a creditor, in any domestic corporation unless it is established that the corporation was at no time a U.S. real property holding corporation during the shorter of the period during which the interest was held, or the 5-year period ending on the date of disposition. If on the date of disposition, the corporation did not hold any U.S. real property interests, and all the interests held at any time during the shorter of the applicable periods were disposed of in transactions in which the full amount of any gain was recognized, then FIRPTA withholding would not apply.
Rates of Withholding
The transferee must deduct and withhold a tax equal to 10% (or other amount) of the total amount realized by the foreign person on the disposition. The amount realized is the sum of (1) The cash paid, or to be paid (principal only), (2) the fair market value of other property transferred, or to be transferred, and (3) the amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer. The amount realized is generally the amount paid for the property. If the property transferred was owned jointly by U.S. and foreign persons, the amount realized is allocated between the transferors based on the capital contribution of each transferor.
A foreign corporation that distributes a U.S. real property interest must withhold a tax equal to 35% of the gain it recognizes on the distribution to its shareholders.
A domestic corporation must withhold a tax equal to 10% of the fair market value of the property distributed to a foreign shareholder if (1) the shareholder’s interest in the corporation is a U.S. real property interest, and (2) the property distributed is either in redemption of stock or in liquidation of the corporation.
- Exceptions from FIRPTA withholding
- Reporting and Paying Tax on U.S. Real Property Interests
- Withholding Certificates
- Format for Applications
- Road Map to Regulations
- Definitions of terms and procedures unique to FIRPTA
For additional information on the withholding rules that apply to corporations, trusts, estates, and REITs, refer to section 1445 of the Internal Revenue Code and the related regulations. For additional information on the withholding rules that apply to partnerships, refer to discussion under partnership withholding. Also consult IRS Publication 515, section U.S. Real Property Interest.
Can you avoid FIRPTA altogether?
Generally the answer is no, however there are some exemptions, of which the most commonly used are: (1) the transaction is for the purchase of a personal residence for $300,000, or less; (2) the transaction is a non-recognition transfer; (3) or the amount realized on the transaction is zero. For the most part, these limited exemptions will not be of any help, which leads to the final recourse available, applying for a federal withholding reduction in the form of a “withholding certificate.” The grounds for requesting this reduction are that the amount withheld exceeds the actual capital gain tax liability. If the application is submitted prior to the closing date on the transaction, the 10% that is withheld is paid into escrow. As your closing attorneys we would retain the funds until we receive a letter from the IRS confirming the reduced amount. The IRS then receives the appropriate portion of the funds in full satisfaction of the capital gain tax, and the remainder is remitted to the seller, including interest accrued on such funds.