If you purchase real property from a foreign person or entity, you may be required to withhold taxes from your payment to the seller under the Foreign Investment in Real Property Tax Act (FIRPTA). The federal tax law is designed to ensure that foreign sellers pay any applicable capital gains tax on profits realized from the transaction. FIRPTA compliance is equally important for buyers because if you fail to comply, you could be held liable for a portion of the foreign seller's taxes.
When FIRPTA Withholding Is Required
FIRPTA requires that purchasers of U.S. real property interests from foreign persons withhold 15% of the purchase price and send it to the Internal Revenue Service (IRS). When the foreign seller files a U.S. tax return, the amount withheld is credited towards any tax due.
Definition of Foreign Person
FIRPTA withholding only applies when the seller is a "foreign person," which generally includes nonresident aliens; foreign corporations that haven't elected to be treated as a domestic corporation; and foreign partnerships, trusts, and estates. If U.S. real property is jointly owned and sold by a foreign person and a U.S. person, buyers are only required to withhold FIRPTA taxes on the foreign person's share of the purchase price.
Definition of U.S. Real Property Interest
Only U.S. real property interests are subject to FIRPTA withholding. A U.S. real property interest is an interest 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). The definition also covers any interest, other than 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.
Exceptions to FIRPTA's Withholding Requirements
As with many tax laws, application of FIRPTA's withholding requirements is not always straightforward. For instance, FIRPTA withholding is not required in the following circumstances:
- The buyer acquires the property for use as a residence and the sales price is not more than $300,000. The withholding rate is reduced to 10% for properties sold for less than $1 million and that the buyer intends to occupy as a residence.
- The property disposed of is an interest in a domestic corporation if any class of stock of the corporation is regularly traded on an established securities market. However, this exception does not apply to certain dispositions of substantial amounts of non-publicly traded interests in publicly traded corporations.
- The disposition is of an interest in a domestic corporation and that corporation furnishes the buyer a certification stating, under penalties of perjury, that the interest is not a U.S. real property interest.
- The seller gives the buyer a certification stating, under penalties of perjury, that the transferor is not a foreign person.
- The buyer receives a withholding certificate from the IRS that excuses withholding.
- The amount the seller realizes on the transfer of a U.S. real property interest is zero.
- The property is acquired by the United States, a U.S. state or possession, a political subdivision, or the District of Columbia.
- The disposition is of an interest in a publicly traded partnership or trust. However, this exception does not apply to certain dispositions of substantial amounts of non-publicly traded interests in publicly traded partnerships or trusts.
Penalties for FIRPTA Non-Compliance
A seller's foreign status may not always be obvious, particularly when trusts, LLCs, and other entities are involved in the transaction. To avoid unintended liability, due diligence is often necessary to determine whether FIRPTA compliance is required.
Generally, buyers must report FIRPTA withholding to the IRS within 20 days after the sale. Buyers who fail to comply with the FIRPTA withholding requirements may be held liable for the tax owed, along with penalties and interest.
In most cases, the buyer must complete Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. Additional compliance is required by the foreign seller to report the sale either on Form 1040NR or 1120-F if a foreign corporation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
