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FIRPTA and Options to Reduce Withholding

Introduction to FIRPTA and Options to Reduce Withholding

FIRPTA stands for the Foreign Investment in Real Property Tax Act that was enacted by congress in 1980. Its purpose is to allow for the US government to be able to collect a withholding tax on the sale of US real property owned by a foreign person. The law was significantly changed in 2016 to increase the percentage of tax withheld to 15%.

What is Real Property?

Real Property is typically identified as land and anything that is directly attached to it – most commonly a building or house. The definition under FIRPTA also includes non-standard items like an interest in a mine, well or natural deposit and certain personal property like farming machinery.

What is the FIRPTA withholding rate?

For foreign individuals, the FIRPTA withholding rate is 15%. For a foreign corporation, FIRPTA withholding is 21%, while a foreign beneficiary of a US Trust or Estate has the highest FIRPTA withholding rate at 35%. Partnerships fall under a special category and are generally exempt from FIRPTA withholding (they are subject to tax withholding under a separate provision).

How do I calculate the dollar amount?

Here is another “fun” issue with FIRPTA – the calculation of FIRPTA withholding tax is based on the SALE price of the property. Unfortunately, the IRS will not take into consideration what you originally paid for the property or how much you spent to replace the roof. Their goal is to make the calculation as simple as possible. As an example, if you are selling a property for $500,000 at 15%, the total FIRPTA withholding tax is $75,000!

There must be something we can do? This is outrageous!!

Absolutely there are ways to reduce FIRPTA! One of the most common tools is to request for the Buyer to sign a Personal Use Affidavit. If the Buyer is willing and able to sign the Affidavit, and if the sale price of the property is less than $300,000, the FIRPTA withholding tax can be reduced from 15% to 0%. If the sale price is between $300,000 and $1,000,000 and the Buyer signs the Affidavit, then the FIRPTA withholding tax can be reduced from 15% to 10%, which can still be a significant reduction.

How does a Personal Use Affidavit work?

There is a lot of misconceptions here, so you may hear different stories from different people. If the Buyer or a member of their family, has definitive plans to reside at the property for at least 50% of the total days that the property is in use by any person over the next two twelve month periods, then they are eligible to sign the Affidavit.

Let’s break down some common misconceptions:

First, the intention of the Buyer must be real. The IRS will consider a change in circumstances only if it could not have been reasonably anticipated at the time of the sale.

Second, the property is not required to be the primary residence of the Buyer, nor does it need to be occupied at all times. The time that the property is vacant does not factor into the formula. As an extreme example, the Buyer could use the property for two days out of the year, and rent it out for one day and it would still qualify for this Affidavit.

Third, the Buyer must purchase the property in their individual names in order to qualify.

Fourth, bare land or an empty lot cannot qualify because there must be a dwelling of some sort on the property.

Fifth, the Buyer signing the Affidavit does not make this transaction any more risky for the Buyer. The Buyer is responsible for making sure that FIRPTA is addressed and this is a perfectly appropriate form for the Buyer to sign.

Sixth, the Affidavit can be used at the same time as the other provisions to reduce FIRPTA withholdings listed below.

What is a Withholding Certificate?

In the right circumstances, a Withholding Certificate can be a great tool for reducing the burden of FIRPTA. I like to describe it as a pre-audit petition to the IRS. The Withholding Certificate allows for you to change the FIRPTA calculation to factor in the purchase price of the property and any major improvements that you made. The IRS typically processes these requests in 90 days or less and then allows for you to receive a refund your money back much quicker. In order for this option to be considered, you must first check with your Closing Agent – either the Title Company or Attorney to ensure that they are able to hold funds in escrow for you. There are also many nuances in successfully filing a Withholding Certificate, so make sure that your IRS representative is familiar before starting this process.

Is FIRPTA forever?

FIRPTA is just a withholding tax. It is the IRS’s way of trying to ensure that any tax that might be owed is collected up front. When a foreign Seller files their US Non-Resident tax returns, they will include the amount paid for the property and major improvements to be able to calculate the actual gain on the sale. The tax return will take into account the FIRPTA tax withholding already submitted to the IRS and any excess withholding will be refunded to the foreign Seller at that point. Think of FIRPTA as more of a timing issue and not a lost cause.

Any final words of advice?

FIRPTA can be a very confusing and upsetting process. Only the most common questions and scenarios have been presented here but know that there are many more options available. Be sure to work with a team who is familiar with all of the possibilities and is willing to explain their recommendations. One seemingly insignificant factor can drastically change the optimal path so make sure that your advisor listens and asks questions about your specific situation.

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