When an individual sells property in the United States, they must pay taxes on that earned income. This tax applies to foreign investors who sell property in the U.S. as well. In fear that foreign investors won’t file tax returns, the IRS requires that a withholding tax be held — which can be thought of as an ‘advance tax payment.’ This requirement is enacted through FIRPTA, which stands for the Foreign Investment in Real Property Tax Act.
This act came about in response to concerns surrounding international investors selling real property in the U.S. and not paying the required taxes. This law applies to non-resident aliens, foreign partnerships, trusts, estates, and corporations that have not elected to be treated as a domestic corporation under the IRC.
There is a system in place that helps determine how much the advance payment will be. If the sales price is over $1,000,000, the withholding tax is 15 percent (increased from 10 percent as of February 16, 2016). If the sales price is between $300,000 and $1,000,000, and the buyer is going to use the property as a primary residence, the withholding tax is 10 percent. If the sales price is under $300,000, and the buyer is going to use the property as a primary residence, the withholding tax is zero.
If the purchaser is a trust or corporation, the withholding tax will be 35 percent. If it is a foreign partnership, it will be 39.6 percent for non-corporate partners and 35 percent for corporate partners.
Foreign sellers can apply to the IRS for a certificate that asserts their entitlement to a reduced- or zero-withholding requirement. If these sellers can demonstrate that their tax liability is less than 15 percent of the purchase price, or that they are selling their property at a loss and owe no tax on the sale, the IRS will then issue a certificate that eliminates or reduces the withholding requirement.
So, Who Is Responsible For Ensuring That The IRS Receives This Payment?
Surprisingly, the buyer is actually the one who is responsible for ensuring that the seller makes the payment – not the IRS. When a U.S. citizen buyer purchases property from a foreign investor, they will need to hold back a percentage of the selling price and make a payment to the IRS on the foreign investor’s behalf. The IRS makes the buyer liable because they don’t want to chase sellers around the world for payment.
Here Is The Process On How Payment Is Made:
Let’s say that you find a property in Florida that you wish to buy. As you begin the process of putting in an offer, you soon learn that the seller – who we’ll call James for illustrative purposes here – is not a U.S. citizen.
Although James is not a U.S. citizen, when he sells his property, he will earn U.S. income. When that happens, he will be responsible for making an estimated tax payment on that income. As a precautionary measure, the IRS will hold onto the tax withholding – whether it be 10 or 15 percent of the purchase price – until James files a U.S. tax return. After he files a tax return and payment is made, if James owes less than what was paid in his withholding tax, he will get a refund. The IRS just uses this tax withholding as a safety precaution to ensure that James files his tax return and pays the correct amount in taxes.
During the purchase process, buyers should make sure to determine the location of a seller to ensure that funds are withheld by the title company and sent to the IRS. If the seller is a foreign person and you fail to withhold the 15 percent tax, you may be held liable for paying several costly out-of-pocket fees. The withholding tax is typically facilitated by a title company, and both the domestic buyer and the foreign seller will need to fill out an IRS 8288 or IRS-8288-A form.
If the foreign seller is conducting a simultaneous 1031 exchange, they must provide a “Declaration and Notice to Complete an Exchange”, which notifies the purchases that there will be no recognition of gain or loss on the sale. A Qualified Intermediary will then be necessary to prepare documentation and send to the closing officer so that the transaction can be closed as a 1031 exchange.
The Bottom Line
There are several penalties and costly fees that the buyer will be responsible for paying if he/she does not ensure that the seller makes proper payment to the IRS. While this overview is meant to educate on FIRPTA’s many rules and regulations, it should not be interpreted in any capacity as tax advice or counsel. As such, it is important to consult with a tax professional who is more in tune with the various intricacies involved in properly executing a FIRPTA-related transaction.