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Are you a foreign investor planning to sell a property in the United States?

It’s critical to understand your responsibilities under the Foreign Investment in Real Property Tax Act (FIRPTA). Property buyers might be required to make tax withholding payments under this act. It can be quite expensive, cumbersome, and cause a substantial headache if you don’t know the rules implemented by FIRPTA for individual sellers.

If you’re someone who’s getting ready to acquire or sell a piece of real estate in the US, this article will educate you about FIRPTA and your responsibility as a seller.

What Is FIRPTA?

According to the IRS, FIRPTA is a mechanism for obtaining capital gains from foreign investors who sell real estate. Because the Internal Revenue Service (IRS) typically lacks an enforcement tool in the event that such taxes are not paid, FIRPTA transfers that responsibility to the buyer.

The term “foreign person” as used in FIRPTA refers to non-resident aliens who do not meet the need for significant residency, including foreign businesses, LLCs, or partnerships. A foreign person may not always be liable to pay the tax debt defined by FIRPTA; instead, that responsibility may fall on the buyer who purchased a US real estate from a foreign person. About 10-15% percent of the proceeds from the sale may need to be withheld by the buyer and submitted to the IRS with Form 8288 or 8288-A within 20 days of the sale.

Keep in mind that this withholding tax is not a final tax, and could potentially be returned in full if the foreign person files their taxes accordingly.

When Does FIRPTA Apply?

FIRPTA for individual sellers states that any transaction in which a foreign transferor is transferring a US Real Property Interest (USRPI) requires special consideration from both the buyer and the seller.

FIRPTA only applies when an individual is buying property from a foreign person or company. This is not something that the buyer or lender may be familiar with or accountable for. We advise buyers to enlist the aid of an attorney or tax advisor in preparing these documents. The buyer and/or foreign seller are all subject to severe fines for failing to comply with these withholding rules.

5 Important Aspects of FIRPTA for Individual Sellers

FIRPTA rules

  1. FIRPTA is a step taken by the IRS to guarantee the collection of any relevant foreign income taxes resulting from the sale. When the foreign seller’s primary residence is outside of the US, this withholding applies mainly for tax purposes.
  2. The FIRPTA withholding, as mandated by law, will increase from 10% of the gross sales price to 15% starting February 17, 2016. Given that the amount of tax owed is a 50% rate hike, it might be a sign that the real estate prices are again rising.
  3. When buying US real estate, it is the buyer’s duty to withhold the appropriate amount from a foreign seller under US law. The buyer may be responsible for the amount and penalties if they don’t comply with this requirement.
  4. The law’s primary goal is to ensure the IRS can collect the relevant income tax due on a transaction. But it also serves as the secondary protection of the buyer by covering the anticipated amount of liability.
  5. The “special agreements” part of the contract should clarify the seller’s foreign resident status if the seller’s agent acts on behalf of a foreign person as defined by FIRPTA. They might also think about providing IRS form filing and expenses. The ideal scenario for the seller’s agent is for their client to hire a CPA and submit form 8288-B, or an application for a withholding certificate before closing.

It is strongly advised to get legal or accounting assistance because withholding regulations can be complicated. This will ensure that you comply and discuss up front to clarify what has to be done rather than be unsure.

The Exceptions You Need to Know

There are two possible withholding rates scenarios if the property’s purchase price is $300,000 or above:

  1. A 10% withholding rate is applied to homes between $300,000 to $1,000,000 where the buyers intend to live as their primary residence. The buyer must declare their intentions in an affidavit that must be signed under penalty of perjury. The seller is still required to submit a US income tax return detailing the transaction, and any appropriate documents or payments.
  2. There is a 15% withholding rate for all other properties amounting to more than $1,000,000. This 15% withholding will only be applied to the final amount of tax and must be reported in a US income tax return. If the actual tax is less than the 15% withholding, the difference is returned to the seller after comparing the deposit and the actual tax. The seller is required to pay the IRS the remaining amount if the difference exceeds the 15% withholding.

One of the vital aspects of the entire procedure is a foreign person’s Individual Tax Identification Number (ITIN). If the seller doesn’t have one, the IRS can provide one after accepting and filling out the Form W-7. Obtaining an ITIN usually takes 6 to 8 weeks, so prompt action is needed.

Applying for a Withholding Certificate

Applying for a Withholding Certificate

Every foreign seller must declare the sale and pay any appropriate income tax on net capital gains. You can do this by filing 1040-NR for Non-Resident Aliens, regardless of whether they recognize a gain or loss on the sale. The tax return must be filed by April 15 of the year after the transaction.

Another important fact to keep in mind is that the seller might request an IRS withholding certificate when the actual tax on the sale is much lower than the 15% withholding. This makes it possible to lower the amount withheld at closing to 10% of the gross sale price.

The closing can occur before the withholding certificate is granted because it typically takes the IRS 90 days to issue one. The closing agent can keep the funds in escrow until the withholding certificate is given. The agent can then send the reduced withholding amount and give the seller their money back. 

Final Thoughts

We frequently receive calls from people looking for advice on what to look out for when selling and investing in real estate in the United States. It is acceptable that the investment is great for our economy, but we must learn what is reasonable to anticipate income tax returns or payments.

This post is intended to be educational, and it is in your best interest to read it and learn what you can. If you need a tax expert knowledgeable in FIRPTA for individual sellers, tax filings, and other tax requirements, don’t hesitate to contact White Sands Tax Solutions today.

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