On December 18, 2015, Congress passed and President Obama signed into law, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), which contains changes to the Internal Revenue Code section dealing with withholding of tax on the sale of U.S. real estate. Under the Foreign Investment in Real Property Tax Act of 1980,commonly known as FIRPTA, foreign investors are subject to withholding on dispositions of U.S. real estate. Effective February 17, 2016, the rate of FIRPTA withholding increases from 10% of the gross sales price to 15%.
It is the responsibility of the buyer of the U.S. real estate to withhold the proper amount from the foreign seller. If the buyer fails to withhold the proper amount, they can be held liable for the withholding. The buyer’s closing agent generally acts on the buyer’s behalf to assist with meeting any withholding obligations.
The previous rules provide for an exception to FIRPTA withholding on the sale of U.S. real estate. No withholding is required if the sales price is $300,000 or less and the buyer (including family members) intends to use the property for personal purposes as a residence for at least 50% of the time the property is in use for the next two 12-month periods following the transfer. The days the property is unoccupied are excluded in the 50% calculation. Vacant land is specifically not eligible for this treatment, even if the buyer intends to build a residence on the property. In order for the exception to apply, the buyer must be an individual, as opposed to a partnership, corporation, estate or trust. This exception remains unchanged under the new rules.
The new rules allow for a reduction of the 15% withholding rate, bringing it back to the prior 10%, if certain criteria are met. To meet the criteria, the sales price cannot exceed $1,000,000 and, just like for the exception to FIRPTA withholding, the buyer must intend to use the property as a residence. As guidance from the Internal Revenue Service is lacking at this time, our interpretation is that the term “residence” is defined in the same manner as for the exception to the withholding described above.
If the actual tax on the sale is significantly less than the 15% withholding (or 10% as applicable), or nonrecognition treatment applies, the seller may apply for a withholding certificate from the IRS. This withholding certificate allows for an amount of less than 15% of the gross sales price (or 10% as applicable) to be withheld from the closing proceeds. This alternative has not been affected by the new rules.
As additional guidance becomes available, the changes mentioned above will, hopefully, be clarified.
Since every situation is unique, we are happy to advise on the options available to buyers and foreign sellers in complying with these requirements.