By John D. Belkin, Garfield & Hecht, P.C.
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) imposes a tax on capital gains recognized by foreign persons from the sales of real property interests located in the United States. Where the seller is a foreign person, the buyer is responsible for withholding.
On December 18, 2015, President Obama signed into law the Protecting America from Tax Hikes (PATH) Act which became effective on February 16, 2016. The PATH Act increases the FIRPTA withholding rate from 10% to 15%. The PATH Act also amended the residential exception criteria, maintaining the withholding rate at 10% for certain qualifying transactions. If the real property is commercial, then no exception applies, and the foreign seller is subject to the 15% withholding rate. If the property is residential, and the buyer is an individual (i.e., not a corporation, partnership, limited liability company), the buyer is acquiring the property as a residence on the date of transfer and the purchase price is equal to or less than $1M, then the seller qualifies for a reduced withholding of 10%.
Unwary buyers are often unknowledgeable of the requirements of FIRPTA – much less its existence – and are surprised to learn that they are required at closing to complete Form 8288, U.S. Withholding Tax Return for Disposition by Foreign Persons of U.S. Real Property Interests and Form 8288-A, Statement of Withholding on Disposition by Foreign Persons of U.S. Real Property Interests and withhold the required 10% or 15% of the sales price. After all, FIRPTA requires that the buyer, not the seller in a real estate sales transaction, is responsible for acting as the withholding agent and ensuring that the IRS receives the correct amount of tax. And while the title company typically prepares the forms for filing and handles the transmission of the withholding funds from the proceeds of the sale to the IRS, the buyer is obligated under FIRPTA to see to it that the tax payment is made, typically within 20 days of closing.
Unless informed by their real estate broker or attorney on review of the title commitment, the buyer will not typically be aware that the seller is a foreign person until preparation of the closing documents. A determination of the applicability of FIRPTA will need to be made. The buyer must determine whether the seller is a U.S. or foreign person. Generally, the IRS defines a foreign person as a nonresident alien individual, a foreign corporation not treated as a domestic corporation or a foreign partnership, trust or estate. Where the seller is a single-member limited liability company, the entity is “disregarded” for tax purposes and the FIRPTA withholding rules apply in the same manner as if the foreign sole member is the seller. The amount of the tax must be calculated; whether that be 10% for residential properties sold for $1M or less that the buyer intends to occupy as its residence, or 15% for commercial property sales. See I.R.C. §1445(a)-(c). The withholding amount can also be eliminated or reduced by way of a withholding certificate from the IRS. The seller must apply for the withholding certificate using Form 8288-B, Application for Dispositions by Foreign Persons of U.S. Real Property Interests before or on the date of closing. The application can be used to show that the underlying tax liability from the sale will be less than the amount of the FIRPTA withholding. The application will require documentation that supports such showing. Only if received by the buyer prior to the sale may the buyer rely upon the withholding certificate for purposes of eliminating or reducing the withholding. If the withholding certificate is not received from the IRS on or before closing, the IRS permits the buyer and seller to set up an escrow of the withheld funds until the withholding certificate is received. If closing occurs without the seller having applied for a withholding certificate, then the tax is due and must be withheld at closing and paid within 20 days. Failure to pay the tax may result in the IRS assessing the full 15% of the property sale price or the seller’s actual tax liability in the sale, whichever is less, plus interest and penalties, as a tax lien against property which will have priority over a first mortgage or deed of trust.
It is not possible in this short article to summarize all the various considerations that go into evaluating the FIRPTA withholding requirements for each real estate sales transaction. Whether you are a buyer required to withhold, or a seller seeking to apply for exemptions or reductions to a FIRPTA withholding, Garfield & Hecht, P.C. has skilled real estate attorneys at various locations to assist you. Where appropriate, we work closely with title companies and the client’s tax advisors and accountants to ensure that FIRPTA withholdings are correctly prosecuted.
In Aspen, please contact John Belkin (970-925-1936, ext. 215, jbelkin@garfieldhecht.com), Chris LaCroix (970-925-1936 ext. 204, clacroix@garfieldhecht.com) or Ron Garfield (970-925-1936, ext. 200, garfield@garfieldhecht.com).
In Glenwood Springs or Rifle, or other locations on the western slope, please contact David McConaughy (970-925-1936, ext. 810 dmcconaughy@garfieldhecht.com), Mary Elizabeth Geiger (970-925-1936, ext. 813, megeiger@garfieldhecht.com) or Haley Carmer (970-925-1936, ext. 815, hcarmer@garfieldhecht.com).
In Carbondale, please contact Kelcey Nichols (knichols@garfieldhecht.com).
In Denver/DTC, please contact Kursten Canada (970-925-1936, ext. 853, kcanada@garfieldhecht.com) or Jason Buckley (jbuckley@garfieldhecht.com 970-925-1936, ext. 851).
In Avon, please contact Kursten Canada (970-925-1936, ext. 853, kcanada@garfieldhecht.com) or Tracy Kinsella (970-925-1936, ext. 854, tkinsellla@garfieldhecht.com).
In Crested Butte, please contact John Belkin (970-925-1936, ext. 215, jbelkin@garfieldhecht.com).
For real estate transactions in Wyoming and Montana, please contact John Belkin (970-925-1936, ext. 215, jbelkin@garfieldhecht.com)
