FIRPTA - Foreign Investment in Real Property Tax

This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

FIRPTA's objective is to force non-resident aliens (NRA) to file U.S. income tax returns and pay tax on U.S. source profits.

The worry was that a foreign person would sell U.S. real estate and forget to file a US Income tax Return. FIRPTA prevents this by requiring Federal withholding of 10% of the sales price, regardless of the amount of profit from the transaction.

California FIRPTA requires 3 1/3% withholding for "foreign persons" (which includes all non-Californiansincluding US citizens moving to another State).

The required payments are deposits on any tax liability owed. Like payroll tax withholding, this money is not lost; it is a deposit on actual tax owed. If too much was withheld, wait until the end of the year and then file a tax return (1040NR) and get it back next April! If no tax is due, the entire deposit will be refunded.

The obligation to make the payments is on the Buyer, escrow, and even real estate agents.

FIRPTA applies to the transfer of all U.S. real property interests, including a sale of an entity which owns real estate.

The first issue is: "Does FIRPTA apply?"

If the Seller is a not a "foreign person" he is exempt. The Seller's Affidavit of Non-Foreign Status (CAR Form AS-14) is used to document the exemption if the Seller is not a NRA.

This can be signed by a:

  1. US citizen;
  2. US green card holder; or
  3. Non-citizen who meets the substantial presence test (based on the number of days actually present in the US).

Remember: to exempt California's 3 1/3% withholding you must continue to be a California resident after the sale.

But see: 2003 UPDATE TO CALIFORNIA WITHHOLDING If the Seller is exempt, nothing further is required. Nothing is filed with IRS.

If the Seller is a NRA, the transaction may still be exempt if it is:

  • A sale for less than $300,000, which property will be the Buyer's personal residence.

    California has a different exemption: sale for less than $100,000, which property was the Seller's personal residence.

If the above exemption applies, nothing further is needed. The Seller should retain the Buyer's Exemption Affidavit (CAR Form AB- 11) as proof of exemption from FIRPTA.

If the above exemptions do not apply, the transaction is subject to FIRPTA. Even so, an exemption from full withholding is available if the Seller's true tax can be proven to be less than the withholding amount. This requires IRS/State approval, applied for with IRS Form 8288-B or California Form 597-A. Some common situations might be:

  • The sale of recently inherited property (for which the step-up in basis applies);
  • A sale at a small profit (or a loss); or
  • A tax free sale (a like-kind exchange under §1031 under which tax is deferred, or the tax-free sale of a principal residence).

IRS Form 8288-B requires a pro-forma tax return and back-up documentation (Probate Court Order, escrow papers, contracts). Within 90 days of a request, the IRS is required to determine if smaller withholding is appropriate.

If the application for reduced withholding is filed (MAILED) with IRS/State before closing, but approval cannot be obtained before closing, escrow will hold the funds pending an answer.

The most difficult issue is convincing the escrow company that it may hold these funds for months, not just 20 days. Every company I have ever dealt with has been difficult in their initial reading of the IRS (and State) form and Regulation which reads: "Funds may be retained in escrow until 20 days after IRS mails its decision on the reduced withholding application."

I have had to prove this to every escrow company, in every single transaction.

If a favorable answer is received, funds are released immediately by escrow to the Seller. If the answer is unfavorable, the funds are sent to the IRS/State, and the Seller must wait until next year, file an Income Tax Return, and wait for his refund of excess deposits.

Any agent who knowingly participates in the evasion of withholding by use of a false Exemption Affidavit or Application is personally liable for the amount of withholding.

My personal experience is that given enough lead time and information, in most appropriate circumstances waivers can be obtained. The State is faster and easier (3 weeks) than the IRS (4 months).

Some interesting fact situations:

  • Seller asks $299,999. Buyer offers $310,000 but Seller insists on the lower price.
  • Seller wants to sell only to owner occupants!
  • Husband is NRA; wife has green card.
  • Tax would be 20% (Federal Capital Gain) + 9% (California) of the profit. A mere 10% + 3.33% of the sales price may be a bargain.

GENERAL INCOME TAX RULES U.S. citizens and U.S. residents are taxable on worldwide income. Thus, an American (citizen or resident) with overseas income may face US plus foreign (double) taxation for property held overseas. In most cases there is a credit for such double taxation, dependent upon the tax rates and Tax Treaties which might apply.

Non-resident aliens are taxable only on U.S. source assets.

U.S. resident for income tax purposes, is any person who has a green card or who meets the "substantial presence test" (180 days in the U.S. during any 12 month period, or an alternative test which requires more than 4 months presence in the U.S.). [A different definition applies for estate taxes; a person may be a U.S. resident for income tax purpose and not for estate tax purposes, or vice versa.]

Special Income Tax Rules. Other than real estate, in general, capital gains are not taxable to non-residents aliens.

Most interest is tax free, unless effectively connected with the active conduct with a U.S. trade or business.

A 30% tax rate applies to both foreign individuals and corporations.

Source: www.wwlaw.com/firpta.htm

For More info visit:  www.irs.gov/businesses/small/int ... 00,00.html