Avoid the Hazards of FIRPTA (Foreign Investment in Real Property Tax Act of 1980)

Date: August 01, 2015 Add to Reading List

Authored by our guest writer and local tax attorney:

Barbara A. Olson

612.436.3293

bolson@olsonlawltd.com

Avoid the Hazards of FIRPTA 

Generally under Federal law, when the Seller of real property is a foreign person, the Buyer is required to collect the tax on the Seller’s gain from the sale by withholding 10 percent of the sales price. If the Buyer does not do so, the Buyer, and sometimes his agents, are liable for payment of the Seller’s tax. 

There a number of possible pitfalls for unwary Buyers of home and other types of real property in the United States from foreign Sellers. This is a tax act. It is complicated. 

The federal law known as FIRPTA (Foreign Investment in Real Property Tax Act of 1980) requires many Buyers to withhold 10 % of the amount realized by their foreign Sellers. This requirement relates to purchases of bare land, homes, buildings, stock in real estate companies and other types of real property interests. 

FIRPTA was enacted because foreign persons and foreign companies that sell US real property are generally subject to US taxes. Needless to say, historically, foreign persons and companies often failed to pay those US taxes. Hence the birth of FIRPTA. 

Red Flags to watch out for: 

  1. The status of the Seller. Ask if the Seller is a US citizen. If not, ask if the Seller is a green cardholder, or a resident alien.  If the Seller is a US citizen or a green cardholder, FIRPTA does not apply. If the Seller tells you he or she is a resident alien, you should get legal assistance to determine the status of the Seller. It involves a rather complicated formula.
  2. Does the Seller have a U.S. TIN (Tax Identification Number)?  If not, the Seller should immediately apply for one. (Forms W-7 or W-7SP).  It takes 4-6 weeks to process. It will be needed for closing and any Certificate of Non-Foreign Status or Withholding Certificate that the Seller may want to provide.   Conversely, if you are representing any non-resident foreign Buyer, have that Buyer apply for a US TIN at purchase. If will make any future sale much easier.
  3. Does the Seller believe that its actual gain on the transaction is less than 10%? The Seller can apply for a withholding certificate from the IRS which allows a reduced amount of withholding. (Form 8288-B)  The IRS says that it takes them two to three months to process those applications. If the IRS has not acted on that application by the closing date, the 10% must be escrowed until the IRS acts.
  4. False Non-Foreign Certificate. If the Buyer, or its agents, have actual knowledge that the Non-Foreign Certificate provided by the Seller is false, and close the transaction without withholding, the Buyer, AND his agents ( attorneys, title agents, and other involved in the closing) can be held liable for the tax, and other civil and criminal penalties. This would be a good time to obtain legal assistance for the Buyer.
  5. Recent Transfers of the Real Property into or out of Corporate Ownership. Given the difference in tax rates between corporate income tax and individual income tax, Sellers sometimes transfer the property out of a corporation immediately before sale. This can have tax ramifications, and the IRS sometimes has the option to disregard the corporate transfer to the shareholder and treat the transaction as a direct sale by the corporation.

Conversely, sometimes a foreign Seller transfer real property to a US Corporation, LLC, trust or partnership, immediately before sale to avoid FIRPTA.  This can be an appropriate transfer, or it can be an attempt to evade federal income taxes. A tip-off of tax evasion would be the instruction by the individual foreign shareholder, member, trustee or partner, to send the closing proceeds to him or her, individually, rather than to the selling entity.  In either of these situations, Buyer should retain legal counsel to avoid any implication that the Buyer or the Buyer’s agents may have aided and abetted federal income tax evasion.

  1. Seller believes the transaction is subject to an exemption from FIRPTA. There is an exemption from FIRPTA if the property is sold from $300,000 or less AND the Buyer intends to use the property as a personal residence for at least two years. However, this exemption can be dangerous to the Buyer. If, for whatever reason, the Buyer does not use the home as a personal residence for the next two years and the transaction is audited by the IRS, the Buyer could be held liable for the 10% which was not withheld.  Some Buyers will not take this risk without some compensation, such as a meaningful reduction of purchase price.