The withholding rules under FIRPTA can be very confusing and have changed over the years. The questions and answers below attempt to address some of the most common situations encountered in complying with the requirements under FIRPTA.
- What is FIRPTA?
When a foreign person sells U.S. real estate, he or she is subject to having fifteen percent (15%) of the gross sales price withheld from the proceeds received at closing. This is a requirement under the Foreign Investment in Real Property Tax Act, known as FIRPTA.
- Is there an exception to the FIRPTA withholding?
If the sales price is $300,000 or less and if the buyer 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 seller could be exempt from the withholding. 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. The buyer must be able, and willing, to sign an affidavit attesting to his intention to use the property personally for at least 50% of the time the property is in use. If the exception applies, the seller still must obtain a U.S. taxpayer identification number if he does not already have one and file a U.S. tax return to report the sale of the property.
- Under what circumstances can the 15% withholding be reduced to 10%?
If the sales price is over $300,000 but not more than $1,000,000 and the buyer 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 (see #2 above), the withholding is reduced from 15% to 10%.
- When is the closing?
The timing of the closing can play a part in the decision of whether the seller wants to apply for reduced withholding rather than remit the 15% (or 10%) withholding to the IRS at the time of the closing. If the closing is taking place in the last three months of the year (October through December), it is likely that there may be limited benefit to the seller in applying for reduced withholding.
The IRS takes at least 90 days to process an application for reduced withholding and, by the time a withholding certificate would be issued, the seller would be able to file a tax return to request a refund. This may not hold true if the seller is a foreign entity as it could have a year-end other than December.
- Does the seller qualify to apply for reduced withholding?
If the closing is taking place prior to October in the calendar year (or there are circumstances that are appropriate for an application to be filed), the seller must be able to show that the tax owed will be substantially less than the 15% (or 10%) withholding.
- What documentation does the seller need to provide for the application for reduced withholding?
The seller will need to provide a copy of the settlement statement on the initial purchase of the property. Proof of no prior withholding liability is also required, which typically is a non-foreign affidavit from the purchase or copies of the IRS Forms 8288 and 8288-A that were submitted at the time of the purchase. If there is a net gain on the sale, the seller can provide copies of invoices for the improvements to further reduce the gain, and show that the maximum tax is significantly less than the withholding.
- What is the difference between remitting the full 15% withholding (or reduced 10% withholding) to the IRS vs. applying for reduced withholding?
When applying for reduced withholding, as long as the application is mailed on or before the closing date, the closing agent is authorized to hold the 15% (or 10%) in the firm’s escrow account, instead of sending it to the IRS, pending the IRS approval. It generally takes the IRS at least 90 days to approve the application and issue the withholding certificate. Once the withholding certificate is issued, the closing agent can release the funds being held on behalf of the foreign seller. If the withholding is not reduced to zero, the closing agent must remit the amount due to the IRS within 20 days of the date on the withholding certificate before refunding the balance of the funds to the seller.
- Do the foreign sellers need to obtain U.S. taxpayer identification numbers prior to closing?
If the seller chooses to remit the full FIRPTA withholding to the IRS at closing, the seller does not need a U.S. taxpayer identification number prior to closing. However, it is suggested that the seller(s) submit IRS Form W-7 to obtain their tax identification number(s) as soon as all of the required documentation is available. If the seller is applying for reduced withholding, the seller must apply for the tax Identification number at the time the application is submitted.
- If the buyers are foreign, do they need to obtain U.S. taxpayer identification numbers?
If the FIRPTA withholding is being remitted to the IRS, the foreign buyers do not need to have, or apply for, U.S. taxpayer identification numbers. However, if the seller wants to apply for reduced withholding, both buyers and sellers must have, or obtain, U.S. tax identification numbers in order to complete the application for reduced withholding.
- Do the sellers (and/or buyers) need to be in the U.S. to apply for U.S. taxpayer identification numbers?
While it is not necessary to be in the U.S. to apply for a number, it does make the process easier. If they are planning to be in the U.S. sometime shortly before or after the closing, we recommend they apply for the numbers while they are here in the U.S. The IRS requires an original signature on the application form, and a certified copy of the passport must be included with the application. The IRS will only accept a certified copy of the passport from the issuing agency (i.e. the passport office issuing the passport) or a U.S. consulate. The sellers may also have their passports certified by a local IRS representative.
- Is a U.S. tax return required?
When a foreign person sells U.S. real estate, a U.S. income tax return is always required to be filed to report the sale of the property. If more than one person holds title to the property, all owners must file a tax return. It does not matter if the FIRPTA exception applied, whether withholding was remitted, or an application for reduced withholding was submitted. Applying for reduced withholding does not eliminate the requirement to file the tax return.