In 2022, the National Association of Realtors (NAR) reported that 24% of international investments in real estate took place in Florida.[1] With its beautiful beaches and endless summer weather, that number probably does not come as a surprise. As the number of foreign investors continues to rise, what happens when these investors decide to sell? As if purchasing property wasn’t complicated and stressful enough, buying from a foreign seller could throw additional complication into the mix with FIRPTA withholding taxes. What is FIRPTA and what does it mean?
WHAT IS FIRPTA?
FIRPTA stands for the Foreign Investment in Real Property Tax Act of 1980. It may apply when a foreign person disposes of their U.S. real property interests. The term disposition includes a sale or exchange, liquidation, redemption, gift, transfers, etc.[2] FIRPTA allows the IRS to collect an estimated income tax percentage owed by non-citizens and/or non-residents of the United States on their gains or earnings from disposition of their US property.
WHO DOES FIRPTA AFFECT?
When FIRPTA withholdings apply, the Buyer bears the greatest burden. In most cases, the person purchasing the property (transferee) is the designated withholding agent. This agent is required to withhold the estimated tax percentage, typically 15%, of the realized amount of the sale (sale price) and remit this tax to the IRS within 20 days of closing. By reporting the sale to the IRS and paying the tax remittance, the buyer has completed their duties as the withholding agent and is then released of their obligations in the FIRPTA transaction. If the buyer fails to ensure the withholding taxes are paid, they may be held responsible for the outstanding tax obligation, plus penalties and interest.
WHAT ARE THE REPERCUSSIONS?
If a person knowingly or willfully produces incorrect information when completing FIRPTA reporting Forms 8288, they can be liable for fines of $10,000.[3] Corporate officers, including title agents and escrow agents, or other responsible persons, including the transferee, may be subject to additional penalties equal to the amount of the withholding tax.
WHAT ARE THE EXCEPTIONS?
The following are some examples of FIRPTA exceptions listed on the IRS website:
- The buyer (transferee) acquires the property for use as a residence and the amount realized (sales price) is not more than $300,000. The transferee or a member of the transferee’s family must have definite plans to reside at the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the date of transfer. When counting the number of days that the property is used, do not count the days the property will be vacant. For this exception, the transferee must be an individual.
- The property disposed of is an interest in a domestic corporation if any class of stock of the corporation is regularly traded on an established securities market. However, this exception does not apply to certain dispositions of substantial amounts of non-publicly traded interests in publicly traded corporations.
- The disposition is of an interest in a domestic corporation and that corporation furnishes the transferee a certification stating, under penalties of perjury, that the interest is not a U.S. real property interest. In most cases, the corporation can make this certification only if either of the following is true.
- During the previous 5 years (or, if shorter, the period the interest was held by its present owner), the corporation was not a USRPHC.
- As of the date of disposition, the interest in the corporation is not a U.S. real property interest by reason of section 897(c)(1)(B) of the Code. The certification must be dated not more than 30 days before the date of transfer.
- The transferor gives the transferee a certification stating, under penalties of perjury, that the transferor is not a foreign person. The certification should contain the transferor’s name, U.S. taxpayer identification number, and home address (or office address, in the case of an entity).
- The transferor can give the certification to a qualified substitute. The qualified substitute gives the transferee a statement, under penalties of perjury, that the certification is in the possession of the qualified substitute. For this purpose, a qualified substitute is (a) the person (including any attorney or title company) responsible for closing the transaction, other than the transferor’s agent, and (b) the transferee’s agent.
- The transferee receives a withholding certificate from the Internal Revenue Service that excuses withholding.
- The transferor gives the transferee written notice that no recognition of any gain or loss on the transfer is required because of a nonrecognition provision in the Internal Revenue Code or a provision in a U.S. tax treaty. The transferee must file a copy of the notice by the 20th day after the date of transfer with the Ogden Service Center, P.O. Box 409101, Ogden, UT 84409.
- The disposition is of an interest in a publicly traded partnership or trust. However, this exception does not apply to certain dispositions of substantial amounts of non-publicly traded interests in publicly traded partnerships or trusts.[5]
FIRPTA Paradigm Decision Matrix: Part A Seller Analysis
The most important step in FIRPTA is determining whether the seller is considered a U.S. person or a foreign person . If an entity or individual is deemed to be a “U.S. person”, then FIRPTA does not apply. This may seem simple, but there are many situations where this determination can be difficult.
Under the I.R.C. §§7701(a)(30)-(31)(A), a “U.S. person” is defines as:
- A citizen or resident of the United States;
- A domestic partnership;
- A domestic corporation;
- Any estate, where its income derives from within the United States or such income is effectively connected with the conduct of trade or business within the United States;
- A trust, where such trust allows for a U.S. court to exercise primary supervision over its administration and at least one U.S. person has authority to control all its substantial decisions.
Note, the term “domestic” refers to an entity created or organized in the United States or under the law of the United States or any of its states. In these situations, FIRPTA does not apply and there are no withholdings required.
Limited liability companies are not included in the above list because, although they may be created in the United States, they may not be classified as a “U.S. person” for tax purposes.6 When dealing with an LLC, it is imperative that additional research into the company be conducted to confirm how it has elected to be classified. LLCs can elect to be treated as a corporation, a disregarded entity, or a partnership.[8] Depending on the classification, a varying degree of research and review of corporate documents is required to determine whether the LLC meets the tax-reporting requirements to be considered a “U.S. person”.
When it comes to sellers as individuals, they can be classified as a “U.S. person” if they are a citizen or a resident of the United States, or as a U.S. resident alien solely for tax purposes. A citizen is generally a person born in or granted naturalization by the United States. A resident of the U.S. is someone lawfully admitted for permanent residence, a person issued an alien registration card, or possessing a Form I-551 (commonly referred to as a green card). Furthermore, a person may be classified as a U.S. resident alien for tax purposes if they meet the “substantial presence test”. The substantial presence test is a numerical formula measuring the days an individual is physically present in the United Sates over the course the year. To meet the substantial presence test, an individual must be in the United States for a minimum of 31 days in the current year, and 183 days during the most recent three-year period (the current year and two years immediately before).[12] If the Seller meets the definition of a “U.S. person”, then FIRPTA does not apply, and withholdings are not necessary. In such a situation, the FIRPTA requirements can be circumvented by retrieving the individual’s travel records from the US Customs and Board Protection website to act as supporting evidence when completing a Nonforeign Affidavit at closings.
THE TAKEAWAY:
FIRPTA is overwhelming and could have buyers second guessing whether getting involved in such a transaction is worth the potential risks. With the help of a knowledgeable attorney and a competent closing team, buyers can rest assured they are abiding by the stringent regulations and avoiding these implications. As in any closing, the best way to mitigate risks is to contact a qualified CPA or tax professional, and have an attorney handle the closing from start to finish.