By Eric D. Oberer, Esq., CLTP
Liability for tax withholdings on a real property sale rests with the buyer under the Foreign Investment in Real Property Tax Act — and it’s not always immediately clear when the Act applies. Buyer beware!
The Foreign Investment in Real Property Tax Act (27 U.S. C. 1445) (“FIRPTA”) requires withholding and submission to the I.R.S. of 15% (or 10%, as applicable) of the gross sales price from the seller’s proceeds for sale of real property by foreign persons. Legal liability for withholding the funds from the seller’s proceeds rests with the buyer, because a foreign seller will often be out of the long-arm reach of the U.S. government for recouping these funds.
Buyer and settlement agent liability can be avoided by reasonable reliance on seller certification of non-foreign status, by property withholding, or, if seller is a foreign person, by the application of the appropriate exception to FIRPTA withholding (e.g., a sale for less $300,000 or less where the buyer(s) will reside in the property as their principal residence). A foreign person is a person who is not a resident alien (i.e., a person without a Green Card or who does not meet the I.R.S. substantial presence test). Determination of foreign status can be complicated, particularly with entities, which is why this flowchart can be useful.
- Real estate transfers by a foreign person are subject to income tax withholding.
- The buyer must confirm whether the seller is a foreign person.
- Failure to withhold creates tax liability for the buyer.
- FIRPTA applies in nearly all transactions — residential and commercial.
- The general analytical framework is to establish whether the seller is foreign and then, if so, look for exceptions.
- A “foreign person” is a nonresident alien individual, foreign trust, or foreign estate.
- It does not include a resident alien individual.
- A resident alien is an individual:
- with a Green Card; or
- who meets the Substantial Presence test.
Substantial Presence Test
The Substantial Presence test is a complex IRS formula. To pass the test, the seller was physically present in the U.S. on at least 21 days during the current calendar year, and 183 days during the current year and the two preceding years, counting all the days of physical presence in the current year, but only with 1/6 of the number of days of presence in the first preceding year, and only 1/6 the number of days in the second preceding years. Days present under temporary visas are not counted.
- Pro tip: Hire a legal or accounting specialist to make this determination.
Liability to the IRS rests with the buyer. It can rest with the settlement agent if the agent accepts a seller certification of non-foreign status that the agent knew or reasonably should have known was false.
- Pro tip: Circulate an affidavit in which all parties swear they reasonably believe the seller is not subject to FIRPTA.
Amount to Withhold
If the seller is indeed foreign, then the buyer must withhold a sum until the IRS claim on the seller is satisfied. The buyer must withhold 15% of the “amount realized,” meaning the gross amount, that is, the contract price.
- Personal residence: The buyer will use the property as a residence and the sale price is $300,000 or less.
- Reduced Rate of Withholding: The buyer will use the property as a residence and the sale price is greater than $300,000 but less than $1,000,000. This exception allows the buyer to reduce the withholding to 10%. This exception arose from the Protecting Americans from Tax Hikes Act of 2015.
- Seller Certification: The seller certifies they are not a foreign person. The certification must include the seller’s name, the U.S. tax identification number, and home address.
- IRS Withholding Certificate: The buyer can obtain a withholding reduction or exemption from the IRS in certain scenarios upon application.
Reporting and Paying the Tax
- The buyer must use Forms 8288 and 8288-A to report any taxes withheld.
- Forms and funds must be received by the I.R.S. within twenty days of settlement.
- The buyer’s tax identification number is required; it cannot be merely applied-for.
Caution: It’s Not Always Immediately Clear If the Act Applies
It is not always immediately clear whether the seller is foreign, that is, whether the Act applies. The property may have multiple owners, one of whom is foreign. In that scenario, the withholding is prorated according to the foreigner’s ownership percentage. Or the seller is a single member LLC with a U.S. citizen as the single member, but the entity is foreign. In that scenario, FIRPTA applies.
The point here is that due diligence is required to ensure FIRPTA does not apply. Hiring a specialist in this area is advisable. The flowchart below is a helpful analytical tool. Part A aids in analyzing the seller’s status. Part B aids in analyzing which if any exceptions apply.
Eric D. Oberer is Maryland and Washington, D.C. Senior Underwriting Counsel at First American Title. Eric can provide you with IRS forms, transactions templates, and a copy of the flowchart to help you navigate FIRPTA.