Implemented in 1980, the Foreign Investment in Real Property Tax Act (FIRPTA) is the tax law that grants the U.S. government the authority to tax foreign persons when they depose of any U.S. real property that they have an interest in. The tax withholding’s primary goal is to guarantee that any capital gains realized from the transaction are properly taxed by the U.S. government.
According to the FIRPTA, a U.S. real property interest includes transactions where the seller conveys their interest in a parcel of real property and/or they sell their shares in a U.S. corporation classified as a U.S. real property holding corporation.
How Does it Work?
It used to be that buyers, their agents, or settlement officers were required to withhold 10% to satisfy the requirements of the FIRPTA. However, with the implementation of the PATH Act of 2015, this amount increased to 15% for transactions occurring on or after February 15, 2016. For example, that would be $60,000 on a property with a sales price of $400,000. The 15% withholding is a security that the Internal Revenue Service (IRS) will receive any taxes due to them. If the tax payment is not made, the IRS has the authority to seize the buyer’s property or their other assets to satisfy the debt.
Are There Any Exceptions to the Provisions of the FIRPTA?
One exception to the withholding requirement of 15% is if the buyer is purchasing real property as their primary residence AND the purchase price does not exceed $300,000. Keep in mind that the buyer must sign an affidavit attesting that the property will be their primary residence to qualify for the exception.
However, buyers must still be careful. Specifically, even if they meet the withholding requirements, buyers may still be responsible for any tax liability, interest, and penalties that the seller is responsible for if the seller fails to file a U.S. income tax return reporting the sale and pay the relevant taxes.
As such, if you purchase your property from a foreigner/non-resident and none of the exceptions to the FIRPTA withholding applies, then it is your responsibility to ensure that the FIRPTA is satisfied when you close on the property. You can review the settlement statement before you close on the property to ensure that the required 15% is withheld as part of the transaction.
Another exception to withholding of the FIRPTA is if the seller obtains a withholding certificate from the IRS. Typically, the IRS processes these applications within 90 days of receiving the complete application. (more on the withholding certificate below).
Your closing agent can give you copies of the withholding certificate if applicable. You can also ask them for copies of 8288, 8288-A along with copies of the canceled check. You should keep these documents for a few years as part of your closing documents in case the IRS requests them.
There are several additional exemptions to the FIRPTA. However, most of them relate to transactions involving U.S. real estate holding companies or in situations where the government is acquiring property.
What if the seller is taking a loss? Does the 15% still have to be withheld?
According to the IRS, there is no automatic exemption if the seller is selling the property at a loss or has no capital gain. As such, the seller must pursue one of the following options if they want to get their money back for the IRS.
Option #1
Specifically, if sellers don’t do anything, the 15% will be remitted to the (IRS) by the title company or closing agent within 20 calendar days after the property’s closing. As their first option, if the foreign seller wants to claim a refund for any amount they believe they overpaid, they must file a tax return during the following year, reporting the sale and any realized capital gain. Once the IRS processes the return and finds an overpayment, it will be returned to the foreign seller.
Option #2
For the second option, a foreign seller can file an application with the IRS for reduced withholding. The seller must submit the application with the legal names, taxpayer identification numbers, and the sellers’ contact information on or before the closing date. The 15% that is automatically withheld will be held with the closing agent or title company until the IRS completes processing the application. As previously mentioned, on average, this takes approximately 90 days.
Once processing is complete, the IRS will issue withholding certificates, and the closing agent or title company will issue the cleared money back to the foreign seller. Keep in mind that even if the foreign sellers file this application, they must file a U.S. tax return, reporting the transaction to the IRS. Also, if it is found that the seller/applicant was merely applying for the certificate as a strategy to delay remitting the taxes, the seller/applicant may be subjected to additional interests and/or penalties.
Specifically, foreign sellers must file tax returns for every year that they received rental income (if applicable) and file a final tax return report on the sale. This process may take twelve to eighteen months, depending on when the property is sold.
To ensure that the funds are released timely, the foreign seller must obtain the following information before closing the property.
- If the buyers are U.S. citizens – the buyer’s names, contact information, address, and social security numbers.
- If the buyers are non-residents – the buyer’s names, contact information, address, and ITINs.
- If the buyers are non-residents and don’t have ITINs – each buyer must complete Form W-7 (one per buyer) and a verified copy of their passport.
If this information is incomplete or not processed, the application will be rejected. To avoid this scenario, most experienced Realtors will include this requirement as a contingency in the sales contract.
Conclusion
Overall, pursuant to the FIRPTA, the IRS has the authority to tax foreign sellers 15% when the property closes. As such, if sellers do not do anything, the 15% will be automatically withheld at the closing and remitted to the IRS by the closing agent within 20 calendar days after the property closes.
Since the IRS has the authority to take a buyer’s property or other assets to recoup the tax that foreign sellers are responsible for paying, it’s in the buyer’s best interest to ensure that the tax is withheld at closing. Or alternatively, withhold the appropriate amount pursuant to an IRS-issued withholding certificate.
If you are a Florida buyer or foreign seller and have any additional questions or concerns about how the FIRPTA applies to your transaction, please email Tamara at [email protected] or call 954-471-8904.