On the surface, the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), P.L. 96-499, seems straightforward enough: Foreign persons must pay a 10% or 15% tax when they sell a piece of U.S. real estate.
As always, though, the devil is in the details. And there are many details, exceptions, and complicating factors. Consider this brief excerpt from Sec. 1445 related to FIRPTA, for example:
If a domestic corporation which is or has been a United States real property holding corporation (as defined in section 897(c)(2)) during the applicable period specified in section 897(c)(1)(A)(ii) distributes property to a foreign person in a transaction to which section 302 or part II of subchapter C applies, such corporation shall deduct and withhold under subsection (a) a tax equal to 15 percent of the amount realized by the foreign shareholder.
If you think that was fun reading, there are 2,500 more words and numerous sets of parentheses in Sec. 1445, and there have been numerous amendments over the past 40 years. It turns out FIRPTA is quite a complex beast.
This discussion does not take this highly complicated tax topic and magically make it as easy to understand as a third-grade math book. What it does is drive home a few very clear points that do not require anyone to get a Ph.D. in international taxation.
The main points to take from this discussion include:
Got those four things down? Good. But knowing that the devil is, indeed, lurking in the details, it is time to buckle up and dive deeper.
The basics: What FIRPTA is and how it works
FIRPTA imposes a tax on capital gains derived by foreign persons from the disposition of U.S. real property interests. Withholding of the funds is required at the time of sale, and the payment must be remitted to the IRS within 20 days following closing.
In most cases, the buyer is responsible for making sure the IRS receives its money within 20 days. The buyer usually is the withholding agent and is ultimately responsible for sending the funds to the IRS. The title company normally facilitates this function, but this does not imply the buyer has escaped his or her obligation as the withholding agent.
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, where they will enter the amount subject to 10% or 15% withholding.
The withholding rate is 10% for properties sold for less than $1 million and that the buyer intends to occupy as a residence, but no withholding is required if the sales price is $300,000 or less. The withholding rate is 15% for a property the buyer does not intend to use as a residence, regardless of the sales price.
Foreign persons and US persons
The big question in determining if FIRPTA applies to a deal is whether the seller is a foreign person or a U.S. person. As noted before, the buyer acts as the withholding agent, so it is imperative that he or she exercises utmost due diligence on this question, recognizing that the seller's U.S. or foreign status is not always obvious.
It also is not always simple. The IRS defines a foreign person as a nonresident alien individual, a foreign corporation not treated as a domestic corporation, or a foreign partnership, trust, or estate. A seller who is a U.S. citizen or a U.S. permanent resident (green card holder) is generally exempt from FIRPTA withholding.
Keep in mind also that having an individual tax identification number (ITIN) has no bearing on whether the seller is a foreign person or a U.S. person. The IRS issues ITINs to help individuals comply with U.S. tax laws and to provide a means to efficiently process and account for tax returns and payments for those ineligible for SSNs. The IRS webpage "Individual Taxpayer Identification Number" (visit tinyurl.com/y8lts4y8) says:
[ITINs] are issued regardless of immigration status, because both resident and nonresident aliens may have a U.S. filing or reporting requirement under the Internal Revenue Code. ITINs do not serve any purpose other than federal tax reporting.
For an individual who is neither a U.S. citizen nor a permanent resident, the determination of whether the individual is a U.S. person for income tax purposes (and thus not subject to FIRPTA withholding) is made using the "substantial presence test." This test addresses where the person in question spends his or her time, regardless of citizenship status.
A seller will be considered a U.S. resident and subject to U.S. taxes if he or she meets the substantial presence test for the calendar year. He or she will be considered as substantially present in the United States if he or she is physically present in the United States for at least:
If the calculation outlined above indicates the seller is not a foreign person, the buyer should obtain from the seller and file what is commonly known as a "FIRPTA affidavit," attesting to the seller's nonforeign status.
Clearly, questions of substantial presence — and FIRPTA overall — can be tricky. That is probably why the Texas Real Estate Commission, for example, says:
A prudent broker will have a list of CPAs or attorneys who are familiar with FIRPTA to provide to a seller with a foreign status. The CPA or attorney can guide the seller and advise them regarding their tax obligations under this law. A license holder should NOT take it upon themselves to determine whether or not the seller has a tax obligation under FIRPTA.
Common FIRPTA situations and common mistakes
One problematic scenario that pops up quite often involves a seller that is a single-member limited liability corporation (SMLLC).
The common mistake here is assuming that the seller is a U.S. person, exempt from FIRPTA withholding, simply because the SMLLC was formed in the United States. One must determine whether the SMLLC's member is a U.S. person or foreign person. The same rules outlined above apply. It is about the status of the SMLLC's member, not the location of the SMLLC.
The lone exception is when the SMLLC's member had previously made a tax election to be treated as a corporation.
That situation is the proverbial tip of the iceberg when it comes to challenging FIRPTA scenarios. There seem to be infinite "what ifs" that can make everyone involved scratch their heads, but some relatively frequent issues include:
Mitigating the tax obligation
Withholding can often be reduced or eliminated with proper planning, with help from a document known as a withholding certificate. The seller can use this document to show that the underlying tax liability from the sale of real property will be less than the amount of FIRPTA withholding. Supporting documentation must be included to support this claim.
But beware: The seller must apply for a withholding certificate, using Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests, before or on the date of closing. If the withholding certificate is received prior to the sale, the buyer can rely on the withholding certificate for zero or reduced withholding.
If, however, the withholding certificate is not approved at the time of the transaction, the IRS permits the buyer to place the withholding in escrow until the IRS responds by either approving the seller's withholding certificate or denying it. It is a good idea to have an attorney act as the withholding agent, with authority over the escrow funds, while the IRS reviews the application. If the IRS approves the withholding certificate, the buyer should then remit the amount placed in escrow back to the seller. If the application is denied, the buyer must remit the full amount to the IRS.
Becoming better prepared
The time to get prepared for a complicated FIRPTA transaction is before encountering one. Get to know CPAs and attorneys who have a significant portfolio of FIRPTA experience. Expert assistance can help a buyer avoid being surprised with a heavy IRS obligation.
The prudent professional — and the client — will be much better off calling in expert help from someone who has spent considerable time plowing through Secs. 897 and 1445.
EditorNotes
Marcy Lantz, CPA, CSEP, is a partner with Aldrich Group in Lake Oswego, Ore. Ms. Lantz would like to thank the following practitioners for their help editing the December Tax Clinic: Michael T. Odom, CPA, CVA, partner at Fouts & Morgan CPAs PC in Memphis, Tenn.; Carolyn Quill, CPA, J.D., LL.M., principal at Thompson Greenspon CPAs & Advisors in Fairfax, Va.; Kristine Boerboom, CPA, CMA, MBA, partner at Wegner CPAs in Madison, Wis.; and Todd Miller, CPA, partner at Maxwell Locke & Ritter in Austin, Texas.
For additional information about these items, contact Ms. Lantz at 503-620-4489 or mlantz@aldrichadvisors.com.
Contributors are members of or associated with CPAmerica, Inc.