Why was FIRPTA enacted?
Prior to 1981, foreign persons (so long as their activities in the US did not rise to the level of “trade of business”) were often tax exempt on the sale of real property in the United States. However, in the early 1980’s, the US became concerned about foreigners buying up significant amounts of US real estate. Congress subsequently passed FIRPTA to require all foreign persons to pay tax on dispositions of any interest in United States real property (including any capital gain received) at the time of transaction closing as opposed to entrusting the subsequent proper tax filings. Further, FIRPTA not only requires the withholding to occur when a subject transaction is closed, it shifts the withholding burden to the buyer, therefore placing the burden on the seller to submit documentation setting forth the true taxable liability to recapture these funds.
How much is the FIRPTA withholding rate?
Depending upon the value of the transaction at hand and the buyer’s intended use of the property, the FIRPTA withholding rate is between 10% and 15% of the gross sales price. It should be noted that transactions below $300,000 may be exempt from FIRPTA withholding if certain other conditions are met. However, for the sale of a home to an investor (i.e. no buyer occupancy) at a sales price of $1,000,000, the withholding amount would be $150,000.
If I’m subjected to FIRPTA withholding, how do I get this money back?
If the withholding amount exceeds the taxable liability, a refund may be due the seller. The process to obtain this refund can take two primary paths
1. File a United States 1040-NR tax return with the IRS, or
2. File for reduced withholding via IRS form 8288-B and then once approved, send written request to the IRS for refund of the excess amount of withholding. Filing the 1040-NR tax return with the IRS is still required but assuming a successful withholding application, the applicant will have already received the excess withholding amount.
Part of the challenge of navigating FIRPTA, however, is the timing in which either of the above can occur. With the right structure and approach, a properly equipped seller can expedite access to capital.
What does this mean to me?
As the seller:
The application of the FIRPTA withholding means that the seller’s funds can be withheld for in excess of one (1) year (until a tax return can / is filed and refund processed or a withholding exemption is granted per above). This means, even in the event where the seller takes a loss on the sale of the property, they may also lose control of 10% to 15% of the sales price until appropriate steps are taken to obtain a refund or obtain a successful withholding exemption (again, worth noting, even in the event of successful withholding exemption, a non-resident seller is still required to file a 1040-NR to stay in compliance with the regulations of the IRS).
As the buyer:
The application of FIRPTA actually requires that the buyer in a real property transaction either: (i) obtain an exemption from withholding (very easy in the case of a domestic seller but can be problematic if not impossible for foreign sellers) or (ii) withhold the 10% to 15% and submit to the Internal Revenue Service within twenty (20) days following close of escrow.
It is worth noting that this is often a transparent process to the buyer of real property from a foreign seller as this, in many cases, is handled by the title/trust company. However, the burden for ensuring compliance with the FIRPTA withholding requirement remains that of the buyer and the buyer must instruct the title/trust company to perform this act. The buyer of a property will be liable for penalties for failure to comply with FIRPTA which can be quite severe. As such, receiving proper advice and counsel as it relates to FIRPTA is extremely important to buyers as well as sellers.
As a real estate agent / professional:
The key to a successful transaction is understanding all of the variables and navigating related issues. This includes making sure a non-resident seller of real property understands the potential 10% to 15% withholding impacts which can and will materially impact decision making. It’s also important that non-resident sellers of real property understand that they have options in this matter. This is where Gary R. Hildenbrand CPA’s can add value and make sure your transactions successfully close.
Joe Canada purchased a vacation home in Phoenix, Arizona in 2010 for $1,300,000 (we will assume, in this example, that Joe’s basis remains $1,300,000 at time of sale) and decided to sell the property in 2016. Unfortunately, the market had declined and Joe entered into escrow to sell the property for $1,100,000 resulting in a $200,000 loss on sale. While not thrilled, Joe was pleased to find the only willing and able buyer in the market and needed these funds to deploy elsewhere.
At closing, in March 2016, Joe’s buyer withholds 15% of the sales price, or $165,000, and submits to the IRS in compliance with FIRPTA. Unfortunately, due to the timing of the close of escrow, and, despite the fact that Joe had a significant loss on sale, Joe will be unable to obtain a refund from the IRS of the $165,000 FIRPTA withholding until after he files his 2016 tax return, which cannot happen until early 2017 (or Joe successfully navigates the protocols for a withholding exemption / reduction and obtains and requests a refund of the excess withholding from the IRS). Joe finds himself in a very difficult situation. Making things worse, Joe’s lender required full payoff of his mortgage at closing requiring Joe to come out of pocket.
If this sounds like a situation that you and/or your clients would like to avoid, contact our cross border tax specialists today!