Understanding the Foreign Investment in Real Property Tax Act (FIRPTA) is essential for both buyers and foreign sellers, as it involves mandatory tax withholding that can impact the transaction process. Whether you are purchasing a property or selling one as a foreign investor, complying with FIRPTA’s requirements helps avoid potential legal or financial complications.
With the vast amount of foreign investment in New York City today, it is important to be aware of FIRPTA requirements. Any foreign seller or individual purchasing real estate from a foreign person should fully understand their responsibilities under FIRPTA, including the obligation to withhold FIRPTA if the seller is not a U.S. citizen. It is critical to get the guidance of a New York foreign investment lawyer who understands and has experience with foreign investment and related IRS regulations. For assistance with FIRPTA and real estate transactions, contact Sishodia PLLC at (833) 616-4646 to schedule a consultation.
What is FIRPTA?
FIRPTA stands for the Foreign Investment in Real Property Tax Act. It requires foreign sellers of U.S. real estate to pay a withholding tax of up to 15% of the sale price. The buyer is responsible for withholding and remitting the tax to the IRS to ensure compliance with U.S. tax law.
The standard withholding rate is 15% of the sale price, though certain conditions may reduce this amount. The foreign seller’s actual tax liability is determined when they file a U.S. income tax return, and if the amount withheld exceeds the tax owed, they may claim a refund.
FIRPTA applies to residential and commercial real estate transactions, as well as sales of shares in corporations that own U.S. real estate. However, there are exemptions and reduced withholding rates available in some cases. For instance, if a property is purchased for personal use and falls below a specific price threshold, the withholding may be reduced or waived.
Understanding FIRPTA requirements is essential for both buyers and foreign sellers in these transactions to avoid complications. The IRS provides guidelines and forms to facilitate withholding and reporting, ensuring the process runs smoothly and that all tax obligations are met under U.S. law.
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.
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.
| 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. |
How Can the FIRPTA Withholding Amount Be Reduced or Waived?
Reduce or waive the FIRPTA withholding amount by applying for a withholding certificate (IRS Form 8288-B) before the transaction closes. The IRS may approve a reduced withholding if the actual tax liability is lower than 15% of the sale price. Buyers must withhold unless the certificate is received in time.
How to Apply for a FIRPTA Withholding Certificate
To apply for a FIRPTA Withholding Certificate, the foreign seller must complete IRS Form 8288-B. This form is used to request a reduction or elimination of the standard 15% withholding tax on the sale of U.S. real property. It’s important to file the form on or before the closing date. Delays in submission may result in the full withholding being applied.
Form 8288-B must include clear and accurate details about the transaction. These include a description of the property, the sales price, and the full names and contact information of both buyer and seller. The form should also state the requested amount of withholding and the valid reason for the request.
Supporting documents are required to complete the application. These may include the signed purchase agreement, settlement statement, and any other documents that help explain the sale and support the requested withholding amount. The form must be signed by the seller or a legal representative with proper authorization.
Once completed, the form and supporting documents are submitted to the IRS. Processing times may take up to 90 days, so early submission is recommended. A timely application may allow the buyer to hold the funds in escrow instead of remitting them to the IRS.
Filing a complete and accurate application can help reduce or eliminate unnecessary withholding and prevent delays in receiving sales proceeds. It’s helpful to prepare well in advance of the closing date to gather all the required information and documents.
At Sishodia PLLC, our highly experienced team of New York City real estate attorneys can help you address 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.
