When engaging in US property transactions, there’s an important tax consideration that both buyers and sellers should be aware of—the Foreign Investment in Real Property Tax Act (FIRPTA). FIRPTA applies when the seller is classified as a “foreign person” under the Internal Revenue Code. In such cases, the buyer may be required to withhold a specific amount for tax purposes. Understanding FIRPTA and its implications is essential to avoid headaches and potential expenses. In this blog post, we’ll explore what FIRPTA entails and discuss the obligations it presents to buyers, sellers, and realtors alike.
What is FIRPTA?
FIRPTA serves as a mechanism to capture capital gains taxes from foreign investors when they sell property in the US. Since the IRS lacks an enforcement mechanism to collect these taxes directly from foreign persons, FIRPTA shifts the obligation to the buyer. Therefore, it is the responsibility of the buyer, not the title or settlement company, to collect and remit the required taxes.
However, the tax liability is not necessarily imposed on the foreign person themselves but rather on the person purchasing US real estate from them. If the buyer is acquiring a property from a foreign person, they may be obligated to withhold a specific amount (either 10% or 15% of the seller’s proceeds) and remit it to the IRS within 20 days of the purchase. It’s important to note that this withholding is not a final tax, and much or all of it may be refunded when the foreign person files their taxes.
When Does FIRPTA Apply?
FIRPTA applies when the property being purchased is sold by a “foreign person.” According to FIRPTA, a “foreign person” includes non-resident alien individuals who do not meet the substantial residency test, as well as foreign corporations, LLCs, or partnerships.
However, not all US properties sold by a “foreign person” are subject to FIRPTA. If the sale price is below $300,000, and the buyer intends to occupy the property as their primary residence, no withholding is required under FIRPTA.
For properties with a sale price of $300,000 or more, two potential withholding rates apply depending on the situation. If the buyer plans to occupy the property as their primary residence, a 10% withholding rate applies for properties priced between $300,000 and $1,000,000. For all other properties, a 15% withholding rate applies.
FIRPTA Obligations for Buyers, Sellers, and Realtors
If FIRPTA applies to the property transaction, the buyer has the responsibility to complete the required IRS forms (8288 and 8288-A) and submit the applicable withholding amount. It is essential for the buyer to seek assistance from a lawyer or tax advisor in preparing these forms, as the buyer’s agent, title company, or lender is not responsible for this process.
Buyer’s agents play a vital role in identifying the residency status of the seller to determine if FIRPTA applies. Most standard sale contracts include a clause where the seller must confirm the applicability of FIRPTA. If it does apply, the buyer’s agent can work with the seller and their agent to establish the withholding amount. It may also be reasonable to request that the seller cover the buyer’s expenses related to tax filing and withholding, which can be held in escrow or paid at closing.
Seller’s agents representing “foreign persons” under FIRPTA should disclose the seller’s foreign residency status in their listing and the special agreements section of the contract. They may also consider offering to cover the buyer’s costs related to IRS form filing and withholding. However, the best practice is for the seller to retain a CPA and file Form 8288-B before closing, reducing or eliminating the FIRPTA withholding requirements.
Navigating FIRPTA with Confidence
Navigating FIRPTA may seem complex, but with a clear understanding of its requirements, buyers, sellers, and realtors can approach property transactions with confidence. As a buyer, be diligent in fulfilling your withholding obligations and seek professional assistance when completing the necessary forms. Sellers and their agents should proactively disclose foreign residency status and explore options to minimize withholding requirements. By adhering to FIRPTA regulations, we can ensure a smooth and successful real estate experience for all parties involved.
