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RPTE eReport

Winter 2023

Buyer Beware — The Foreign Investment in Real Property Tax Act

Eric D. Oberer and Gil O. Acevedo

Summary

  • The Foreign Investment in Real Property Tax Act requires a buyer who purchases real property in the United States from a foreign seller to withhold from seller’s proceeds and submit to the IRS.
  • The IRS’s “substantial presence test” is a complex formula, the seller has to be physically present in the U.S. on for at least 183 days.
  • The buyer is responsible and required to deduct and withhold the tax, and, thus, liable to the IRS for buyer’s failure to do so.
Buyer Beware — The Foreign Investment in Real Property Tax Act
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Synopsis

The Foreign Investment in Real Property Tax Act (27 U.S.C. §1445) (“FIRPTA”) requires and obligates a buyer who purchases real property in the United States (U.S.) from a foreign seller to withhold from seller’s proceeds and submit to the Internal Revenue Service (IRS.) 15% (or 10% for qualifying transactions) of the sales price of the U.S. real property.  

A foreign seller is an entity not organized in the U.S., or an individual person not born in the U.S., not admitted in the U.S. for permanent residence (e.g., issued a Green Card) or who has not met the IRS’s “substantial presence test” for the calendar year in which the property is sold.  Determination of the foreign status of a given seller can be complicated, particularly when the seller is an entity.  This is when the flow chart incorporated herein below can be useful.

Legal liability for compliance with FIRPTA and its withholding requirements rests with the buyer, because a foreign seller will often flee and be out of the U.S. government’s arm’s reach for recouping the withholding amount.  A buyer’s and the settlement and/or closing agent’s liability under FIRPTA can be avoided by their reasonable reliance on a domestic seller’s certification or affidavit of non-foreign status.  Where the seller is a foreign person, liability is avoided through compliance with the withholding requirements or meeting an exception to the withholding requirements (e.g., a sale for $300,000 or less, where an individual buyer will acquire the property and use it as his/her principal residence).  

FIRPTA Generally

  • Real estate dispositions by a foreign person are subject to income tax withholdings.
  • Buyers must determine and confirm whether the seller is a foreign person.
  • Buyer’s failure to withhold creates tax liability to the IRS for noncompliance with FIRPTA and its withholding requirements.
  • FIRPTA applies to residential and commercial transactions.
  • The main analysis under FIRPTA is to determine whether the seller is a foreigner, and, if so, whether the foreign seller falls within an exception, or qualifies for a reduction, to the required tax withholding.

Foreign Person

  • A “foreign person” is an individual not born in the U.S. or nonresident alien.
  • It does not include a resident alien individual, which is an individual:
    • admitted in the U.S. for permanent residence (e.g., issued a Green Card); or
    • who meets the “substantial presence test.” 

Substantial Presence Test

The IRS’s “substantial presence test” is a complex formula. To meet the test, the seller has to be  physically present in the U.S. on for at least 183 days during the current year and two preceding years, with a minimum of 31 days in the current year.  The days of physical presence are counted as follows:  (a) each day of presence in the current year is counted as one full day, (b) each day of presence within the year before the current year is counted as one-third of a day, and (c) each day of presence two years before the current year is counted as one-sixth of a day. 

  • Pro tip: Retain the services of an attorney or accounting/tax specialist to make this determination.

Liability

The buyer is responsible and required to deduct and withhold the tax, and, thus, liable to the IRS  for buyer’s failure to do so.  Liability can also rest with the settlement/closing agent if such agent accepts the seller’s certification of non-foreign status, where the agent knew or reasonably should have known it was false.

  • Pro tip: Circulate an affidavit in which all parties swear, under oath and penalties of perjury, that they reasonably believe seller is not subject to FIRPTA.

Amount to Withhold

If the seller is indeed foreign, or if the status of seller cannot determine with certainty, then the buyer must withhold the required (or reduced) amount and submit such amount to the IRS using the correct form.

Exceptions

  • Personal Residence: The property involved is residential property, the buyer is an individual and acquiring the property for use as residence, and the sales price is equal to $300,000 or less. 
  • Reduced Rate of Withholding: The property involved is residential property, the buyer is an individual and acquiring the property for use as residence, but instead, the sales price is greater than $300,000 but less than or equal to $1,000,000.  This exception allows the buyer to reduce the withholding from 15% to 10%. (This exception arose from the Protecting America from Tax Hikes (PATH) Act of 2015.)
  • Seller Certification: The seller delivers a certification (or affidavit) stating that seller is not a foreign person under the laws of the U.S.  The certification must include the seller’s name, taxpayer identifying number (social security number), physical home address and a statement, under penalties of perjury, as to its truth and correctness.
  • IRS Withholding Certificate: The buyer may request a withholding certificate from the IRS prior to sale of the property under certain circumstances using the applicable form, where the IRS makes the determination whether withholding is reduced or not required.

Reporting and Paying the Tax

  • The buyer must use Forms 8288 and 8288-A to report and pay the tax required to be withheld.
  • Forms and funds must be received by the IRS within twenty days after the date of the transfer of the property.
  • The buyer’s and foreign seller’s tax identification numbers are required.  If foreign seller (individual) and does not have a tax identification number but is eligible, such seller can apply for one.

Caution: It’s Not Always Immediately Clear If FIRPTA Applies

It is not always immediately clear whether the seller is foreign, that is, whether FIRPTA applies. The property may have multiple owners, where one of those owners is foreigner.  Under these circumstances, the withholding is prorated according to the foreigner’s ownership interest in the property.  In a different scenario, the seller may be a single-member limited liability company, where the single member is an individual U.S. citizen, but the entity was organized outside the U.S.  Under these circumstances, FIRPTA would apply. 

The message is that due diligence is required to determine whether or not FIRPTA applies, as it may not always an easy task.  Hiring a professional in this area is advisable.  The Paradigms below can serve as tool in determining the applicability of a FIRPTA withholding. Part A aids in analyzing the seller’s status and Part B in analyzing which exception, if any, apply. 

To Withhold, or Not to Withhold, That is the Question: A Step-by-Step Approach to the FIRPTA Income Tax Withholding - Florida Bar Journal

FIRPTA Paradigm decision matrix: Part A Seller Analysis

FIRPTA Paradigm decision matrix: Part A Seller Analysis

To Withhold, or Not to Withhold, That is the Question: A Step-by-Step Approach to the FIRPTA Income Tax Withholding - Florida Bar Journal

FIRPTA Paradigm decision matrix: Part B Residential Exceptions

FIRPTA Paradigm decision matrix: Part B Residential Exceptions

To Withhold, or Not to Withhold, That is the Question: A Step-by-Step Approach to the FIRPTA Income Tax Withholding - Florida Bar Journal