Last updated on March 1, 2024

What is FIRPTA (Foreign Investment in Real Property Tax Act)?

In the United States, if you are a domestic citizen, you will be required to pay capital gains taxes on certain items, including the sale of real estate. But a foreign individual who does not pay federal taxes in the U.S. is not taxed for these often significant capital gains on real estate sales. Consequently, the federal government put FIRPTA, or the Foreign Investment on Real Property Tax Act, into place to collect taxes from foreigners who sell real property in the United States.

With the vast amount of foreign investment in New York City today, understanding FIRPTA requirements have become very important. Any foreign seller or individual purchasing real estate from a foreign person should understand their responsibilities under FIRPTA. While many real estate agents don’t fully understand the implications of FIRPTA obligations, it is critical to get the guidance of a New York City real estate attorney who understands and has experience with foreign investment and IRS laws as they pertain to it.

FIRPTA Withholding

The government closely regulates property transactions in the United States involving both citizens and foreign individuals to ensure fair taxation. The Foreign Investment in Real Property Tax Act (FIRPTA) was established with the purpose of preventing foreign individuals or companies from avoiding taxes when profiting from the sale of U.S. real estate.

Enacted as a federal law in 1980, FIRPTA specifically addresses the issue of foreign investors avoiding capital gains taxes in various types of real estate transactions, such as land, stocks, and bonds. Even in present times, FIRPTA remains significant and primarily affects Americans involved in real estate dealings with foreign individuals or corporations.

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Under FIRPTA, a portion of the capital gains derived from a property transfer between an American and a foreign individual or company must be withheld. Although the IRS establishes a standard withholding rate, the actual amount withheld depends on the profit obtained from the sale.

Understanding FIRPTA withholding can be challenging, especially for those unfamiliar with real estate transactions involving foreign entities. It is important to note that ignorance of these requirements is not considered a valid excuse for non-compliance, according to the IRS.

U.S. Real Property Interest Definition

A U.S. Real Property Interest (USRPI) encompasses various forms of ownership in real estate within the United States or the U.S. Virgin Islands. This definition isn’t limited to land or buildings; it extends to interests in mines, wells, and other natural deposits. Additionally, it includes personal property tied to real property, such as agricultural equipment.

Beyond the physical assets, USRPI also covers any stake in a domestic corporation that is not solely as a creditor. However, this definition is subject to specific conditions. The corporation must not have been a U.S. real property holding corporation during the shorter of these periods: the time the interest was held, or the five years preceding the sale of the interest.

An exemption arises for dispositions after December 31, 2004. Sales of interests in domestically controlled qualified investment entities, such as Real Estate Investment Trusts (REITs) or Regulated Investment Companies (RICs), do not constitute the sale of a USRPI. For an entity to be considered domestically controlled, less than half of its equity must have been owned by foreign persons throughout the testing period, which is defined as the lesser of the five years before the sale or the entity’s total period of existence.

Understanding the nuances of what constitutes a U.S. Real Property Interest is crucial for tax implications, especially for foreign investors. The distinction of whether an interest falls under this definition can significantly impact the tax treatment of profits from its disposition.

Before the Foreign Investment on Real Property Tax Act

Before FIRPTA was enacted in 1980, foreign sellers were not subject to any taxes for capital gains upon the sale of U.S. real property. But this was viewed as a competitive advantage to foreign investors who owned property here.

Congress removed that perceived advantage by requiring that foreigners pay a tax based on the gross amount realized by a foreign seller of domestic real estate. Under Section 897 of the Internal Revenue Code, any sale of a domestic property interest by a foreign individual is now connected to laws regarding the conduct of a trade or business, converting the income from the sale as taxable income.

What Are the Responsibilities of Buyers and Sellers in These Types of Transactions?

To ensure that this tax is collected, a buyer purchasing a property from a foreign individual is required to withhold a percentage of the purchase price of the property. This will be held by the IRS to offset any taxes owed on the sale. The seller will receive a refund if taxes are calculated as less than the amount withheld.

There are different withholding rates based on the sales price of the property.

  • If the sales price of the property is less than $300,000, FIRPTA may not be applicable. In this case, the buyer must certify that the property will be used as a residence for more than 50% of the first two years after the sale.
  • If the sales price of the property is $300,000 to $1 million, FIRPTA taxes must be withheld at a rate of 10% of the amount realized.
  • If the sales price of the property is over $1 million, FIRPTA taxes must be withheld at a rate of 15% of the amount realized.

Within twenty days after the purchase of the property, the buyer of the property is required to file Form 8288 with the Internal Revenue Service with the amount withheld from the seller. Penalties for non-compliance can be significant.

Exceptions Regarding FIRPTA

There are instances where the amount withheld can be reduced or eliminated altogether. If you are a foreign individual who is selling a piece of domestic real estate or a buyer who is purchasing from a foreign seller, you should understand your obligations and options as they apply to FIRPTA.

At Sishodia PLLC, our highly experienced team of New York City real estate attorneys can help you navigate FIRPTA or any other issues concerning your real estate transaction. Contact us at (833) 616-4646 or schedule an initial consultation with us via our online contact form.

Foreign Investment in Real Property Tax Act (FIRPTA) Description
Purpose Collects taxes from foreigners selling real property in the United States.
Responsibilities of Buyers and Sellers Buyers withhold a percentage of the purchase price, held by the IRS to offset taxes owed. Sellers may receive a refund if taxes are less than the amount withheld.
Withholding Rates Sales price < $300,000: FIRPTA may not be applicable. Buyers certify property as a residence for over 50% of the first two years. Sales price $300,000 - $1 million: 10% withholding. Sales price > $1 million: 15% withholding.
Filing Requirements Buyers file Form 8288 with the IRS within twenty days, including the withheld amount.
Exceptions Some cases allow for reduced or eliminated withholding. Buyers and sellers should understand their obligations and options.
Penalties Non-compliance with FIRPTA can result in significant penalties.

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