The Foreign Investment in Real Property Tax Act of 1980 is a United States tax law that imposes income tax withholding on foreign persons or corporations regarding the disposition of investments in United States real property interests. Buyers, agents, and settlement officers purchasing U.S. real property interests from foreign persons are required to withhold 15% of the gross sales price realized on the disposition as a deposit owed to the IRS within 20 days of closing. For any purpose of the Internal Revenue Code, “dispositions” include, but are not limited to, a sale or exchange, liquidation, redemption, transfers, etc.
Anyone who purchases U.S. real property from a foreign individual or corporation must require that the seller pays taxes on the property. FIRPTA must be filed and processed promptly, within 20 days after the sale, and 15% of the gross sales price must be withheld, most often in an escrow account, before being submitted to the IRS. If FIRPTA taxes are not paid before the foreign person leaves the country, the buyer will be legally obligated to cover the taxes themselves. The exception to this is a new law enacted in 2020 that allows the buyer’s certification of residential use to reduce the seller’s withholding rate to 10%.
Who Is Considered a Foreign Person Under FIRPTA?
A foreign person is any nonresident alien who cannot either claim green card status or U.S. citizenship. The substantial presence test of the test advised and conducted by the IRS set a time and whether or not nonresident aliens should be treated as taxpayers in the United States. Anyone who does not pass this essential present test is considered a foreign person in the eyes of the international revenue service.
Anyone who plans to purchase real property in the U.S. from a foreign individual is required to make sure that the seller pays the FIRPTA withholding. The buyer must withhold 15% of the sales price from the seller and deposit the tax to the IRS. A withholding holding agent will be personally liable for the full amount of FIRPTA withholding tax required to be withheld, plus penalties and interest. The buyer is ultimately liable for the proper FIRPTA filings. If the certifications, withholdings, and taxes are not in order before a foreign person leaves the country, the buy will be stuck paying all costs involved.
A foreign seller will not be required to pay FIRPTA if:
- The sales price is $300,000 or less and;
- The buyer signifies before closing that the property will be occupied for personal use and reside in such for at least 50% of the time within the first 24 month period. Due to changes by the IRS regarding FIRPTA, risks regarding this option to buyer, seller, and all agents involved may occur if:
- the seller does not pay standard taxes required upon transfer of real property or if the buyer neglects to meet residency requirements. Keep in mind, the buyer certification of residential use for exemption from further withholding only exempts the buyer from the requirements. The seller will still need to pay state and local taxes regarding the transfer of real property.
- The amount the transferor realizes on the transfer of U.S. real property interest is zero.
- The buyer can also receive a withholding certificate excusing the withholding from the IRS. Unfortunately, this option means the seller needs to file what could be considered a small tax return to prove eligibility for certification, generally requiring the services of a licensed CPA.
- The buyer can request the seller furnish a Non-Foreign Status Certification stating, under penalties of perjury, that the transfer is not a foreign person and contains a transferor’s name, U.S. taxpayer identification number, and home address.
- Consideration is paid, such as in the transference of a gift.
- The seller may be able to pass a substantial presence test regarding the legal amount of time spent in the U.S., but the complexity of this exemption could prove difficult in providing the proper documentation of the foreign seller’s presence in the United States for the appropriate period necessary for such claims.
The buyer is responsible for making sure that the 15% FIRPTA withholding is paid; failure to follow up with the processing of the withholding could result in the buyer being responsible for paying the IRS in its entirety. The seller or their agent is required to sign the FIRPTA certification unless the buyer is willing to sign themselves and assume all risks involved in paying the tax. The buyer would then have to deal with the withholding requirements by applying for the withholding certificate or by already having the 15% tax due at closing on the seller’s behalf. Regardless of who signs, the seller will need to produce an individual tax identification number (ITIN). An ITIN can be applied for at the time of the withholding in the case that a seller has not previously obtained one.
Recent changes to the Internal Revenue Service’s procedure affecting buyers and sellers that will be moving forward with a Foreign Investment in Real Property Tax Act certifications make compliance slightly more difficult than previous allowances and create a larger risk, meaning there are substantial issues that could hinder a successful closing. This risk increases tax liability for buyers and realtors alike. Without proper knowledge or education regarding FIRPTA, the buyer or their agents could be at serious risk of non-compliance with the IRS and become responsible for all penalties therein. Understanding the intricacies of FIRPTA is essential when dealing with property transfers involving foreign persons.
To receive a FIRPTA tax refund, there are two options when it comes to the initial withholding. You may file for a reduced withholding certificate at closing, in which the closing agent will hold the 15% for 90 days until the IRS responds, authorizes the release amount, and returns the portion of your refund immediately. Without the reduced withholding certificate, the buyer will remit the 15% withholding to the IRS at closing within the 20 days required by the IRS, and the seller will file their standard year-end tax return and wait for the refund, typically within 3-4 months. The withholding amount is based on the gross sale instead of the net gains, meaning that most FIRPTA withholdings will be more than the actual amount owed, allowing the seller to claim a refund on yearly taxes.
Buyers that are purchasing US real estate owned by a foreign seller need to be familiar with FIRPTA as they need to withhold approximately 15% of the purchase price from the seller to ensure they pay US taxes. If a buyer does not withhold the money according to FIRPTA, they will be held responsible by the IRS. As such, it's imperative that buyers comply with FIRPTA withholding procedures.