Real Estate: FIRPTA
Our law firm specializes in international law and, as such, caters to foreign investors. For investors that come to us early, we are able to structure their US holdings in a way that avoids unnecessary complications, such as withholdings under the Foreign Investment in Real Property Tax Act (FIRPTA). For those who come to us after the fact, we offer the following analysis.
I. Overview of FIRPTA
Simply put, FIRPTA is legislation intended to insure foreign owners of US real property pay the capital gains tax when they sell their property. After all, there is a natural temptation for someone living abroad to simply sell the property and disappear without paying tax.
The IRS knows this, so they have put the obligation on the buyer and the title agent to withhold 15% of the sale price (10% for qualifying transactions) as a sort of escrow for payment of capital gains tax. So, it’s not the seller that gets in trouble if the withholding is not done.
Since it can be hard to go after the foreign seller, the law is aimed at the parties the IRS knows it can find and punish.
For the most part, the 15% is calculated on the sale price, not the profit realized by the foreign seller. So, usually, the withholding is a substantial amount, which is why clients come to us for help.
For a title agent, dealing with foreign sellers represents tremendous liability. In fact, our office often receives referrals from title companies that are less familiar with international transactions.
Title agents who are unaccustomed to dealing with FIRPTA can get freaked out and end up making the process more slow and painful than it needs to be.
II. The Typical Scenario
Sometimes the foreign investor does not know about FIRPTA when making the purchase. So, instead of creating a domestic land trust or LLC to purchase the property, the buyer just makes the purchase in his or her own name. Given the choice, that approach is not the best for many reasons. Click here for other options.
However, there are other times when purchasing through a land trust or company is not an option. For example, some lenders may require the borrower be a natural person. It is not impossible to get a mortgage in the name of a company or trust, but it can certainly be more difficult. That said, since foreign buyers usually do not rely on US financing for their purchases, this is not generally an issue.
When it is time to sell the property, these are the questions to ask:
(i) Can I avoid the withholding requirement altogether?
(ii) If I can’t avoid withholding, can I minimize the amount withheld? (10% instead of 15%)
(iii) If I can’t avoid withholding, can I at least get a quick refund?
Of course, each situation is a bit different, so do not hesitate to contact our office (free consultation) when you have a situation with a particular closing. But, if you are looking to generally educate yourself, this article is for you.
III. Withholding Requirement
First of all, how do you calculate the the withholding? The IRS uses the term “amount realized” from the sale, which is defined as:
- The cash paid (usually the purchase price);
- The fair market value of other property; or
- The amount of any liability assumed by the transferee after the transfer.
Sellers often say to us “But, I’m not making any money on the sale.” Ultimately, the amount of tax liability will depend upon the profit or loss from the transaction. But, that determination happens at the end of the fiscal year when you file your tax return. Unfortunately, for purposes of the FIRPTA withholding, you do not get to “self-declare.”
So, you may very well get the withholding back after you file your tax returns. But, at the time of the closing, the IRS wants to hold onto 15% (or 10%) of the sale price for you.
Who is a “US person”?
If the seller is any of the following, then FIRPTA does not apply:
- a citizen or permanent resident of the US
- a non-resident who meets the “substantial presence” test
- a domestic, multi-member LLC
- a domestic partnership
- a domestic corporation
- a trust domiciled in the US that has at least one trustee who is a US person
- any estate that derives income from within the US
Who is a “resident”?
If you have a green card (i.e. permanent resident), then you are a US person, irrespective of how many days you have been physically present in the US.
If you are not a permanent resident, but have spent 183 days or more in the US in the past three years, then you are considered a “US person” for tax purposes. The calculation of the 183 days (i.e. the “substantial presence test”) is a bit complicated:
- a minimum of 31 days in the current calendar year
- each day present in the current year is counted as a full day
- each day present within the preceding year is counted as one-third of a day
- each day present within the year that is two years prior to the current calendar year is counted as one-sixth of a day
Tip: The easiest way to do the math is to access Homeland Security’s I-94 page online. That will give you a clear record of the time you have spent in the US during the most recent five (5) years.
What if the property has more than one owner?
If the property is owned jointly by U.S. and foreign persons, the “amount realized” is allocated between the seller parties based on the capital contribution of each.
Example: If there is one US investor and one foreign investor, and they each put in 50% of the price to acquire the property, then the “amount realized” for FIRPTA purposes will be half the sale price.
What if the owner is a company?
If the seller is a foreign corporation, then the company must withhold 35% of the gain it recognizes on the distribution to its shareholders. So, using a foreign corporation as your investment vehicle is usually not smart.
Residence that costs less than $300,000
Probably the most common exception is where the buyer intends to live in the property as a home, as opposed to acquiring the property for rental/investment purposes. That will work, but only if the sale price is less than $300,000.
Additionally, for the first two years, a family member has to live in the property “for at least 50% of the number of days the property is used by any person.” So, that means, the days the house is vacant do not count, but you cannot have a tenant in the property for more time than you or your family use the property.
Limited Liability Company as Seller
This is where things get interesting. Real estate investors often hold their properties in LLCs, so this is the section that merits the most careful analysis.
First of all, if the LLC is registered in a foreign country, then it is subject to the FIRPTA withholding unless it is a single-member LLC and the owner is a US person.
The real question, though, is what to do with domestic companies.
Disregarded Entity. Under the tax code, there is the concept of a “disregarded entity.” If the LLC has only one owner (i.e. member), and the owner has not made any special elections with the IRS, then the LLC will be considered a “disregarded entity.” In that case, whether FIRPTA withholding is required or not will depend upon the status of the owner. If that individual or entity is a non-US person, then the LLC is subject to the withholding.
Multi-Member LLC. By contrast, if the LLC is has more than one owner, then the default classification (i.e. no specific election taken) is “partnership,” not a “disregarded entity.” So, a multi-member domestic LLC will generally not be subject to withholding.
An LLC formed in the US can safely sign the non-foreign affidavit and forgo withholding if _
- It has only one member and that member is a non-US person
- It is has more than one member
- It has made the election to be taxed as a corporation (i.e. C-corp)
If the seller provides a declaration that he or she is not a foreign person, and provides a tax ID number (i.e. social security or EIN), then that will get the buyer and title agent off the hook. Obviously, if the information is false, the seller will be guilty of perjury and could have problems with the IRS. The same is true if the buyer and/or title agent actually knows the information is false.
No Gain or Loss
If the transfer was to a family member, or some other situation where there truly was no profit or loss on the transfer, then the seller can provide a notice to that effect. In that case, the buyer and title agent will not be liable. Just be sure a copy of that notice gets filed within 20 days of the closing at the Ogden Service Center, P.O. Box 409101, Ogden, UT 84409 .
This exception may also apply in short sales, but that is not automatic because the calculation is based on the sale price rather than proceeds. So, contact our office on that one.
This is where your experienced, resourceful lawyer can really be helpful. There are certain mechanisms available for obtaining waiver of the withholding requirement. There are three in particular that provide some wiggle-room.
- The amount to be withheld is greater than the tax liability. The withholding is calculated on the full sale price, even though you may have a mortgage to pay off. Ultimately, of course, you will only have to pay tax on your profit, not the full sale price. So, it could very well be that your tax liability is lower than the amount of the withholding. When that is the case, we should be able to get you a waiver.
- Agreement to pay tax with conforming security. Since the whole idea of FIRPTA is to make sure sellers pay the capital gains tax, the IRS will consider waiving the withholding requirement as long as it has other assurances the tax will be paid. These are the forms of security that are generally acceptable:
- bond with surety or guarantor
- bond with collateral (the Ibis property would probably work)
- letter of credit (if you have funds abroad, this may be an option)
Under this scenario, we (the title company) would first determine the exact amount of tax due on the transaction, and then make arrangements to provide assurances that the tax will be paid before April 15. If we can do that to the satisfaction of the agent, the IRS will issue a waiver.
- Nonstandard application. This analysis really has to be done case-by-case, though I can give you an example. One client wanted to sell his property in order to raise enough money to meet the requirment for an investor visa (E-2). In that case, the argument was really quite compelling. After all, the IRS just wants to know the seller will not disappear without paying tax. Well, if the very reason for the sale is to be able to remain in the US on a long-term basis, that is pretty good assurance the seller will pay his taxes. So, we were able to obtain a waiver.
Bear in mind it does take a little time to get the certificate back so, if you decide waiver is the way to go, you will want to get the application together sooner rather than later.
VI. Amount of Withholding
There is one situation where the amount of withholding is 10% instead of 15%. That is where the buyer plans to live in the property (see details above), and the sale price is greater than $300,000 but less than $1 million.
Otherwise, at the time this article is published, the withholding is always 15%.
VII. Refund of Withholding
In general, you would apply for refund after filing your return and paying any tax due. So, how quickly you get your money back–assuming you are entitled to a refund–depends up on you . . . to a point.
You do not have to wait until April of the following year, but you do have to wait until the end of the fiscal year in order to file a complete return. Some exceptions may apply, depending upon your circumstances, but that is the general framework.
Also, there are some mechanisms for early refund but that, again, would really only apply if the withholding were greater than the tax liability. The criteria and process would be the same as in § V above. If you do file for an early refund, the IRS has 90 days to respond.
As usual, the moral of the story is to seek out a lawyer sooner rather than later. Certainly, if you are a foreign investor, it would be worth your while to meet with an HLA attorney to go over options regarding structuring your real estate investments.