FIRPTA and Transfers Between Mixed Status Spouses

Generally, no income tax is recognized in a transfer of property between spouses (or former spouses) incident to divorce if both spouses are U.S. citizens or residents. A transfer of property is incident to the divorce if such transfer occurs within one year after the date on which the marriage ceases, or is related to the cessation of the marriage. However, when either husband (“H”) or wife (“W”) are nonresidents, who own real estate, a single family home, for example, in the United States and are in the process of getting a divorce and dividing their assets, the general rule says that if the spouse (or former spouse) of the individual making the transfer is a nonresident alien, the transferor will have to recognize taxable gain upon transferring all or a portion of the property to the other spouse. For income tax purposes, the transferor will recognize the difference between the fair market value of the property and its adjusted basis. The transferee’s basis in the transferred property would be its fair market value on the date of the transfer.

Below, please see an example which illustrates the different tax treatment in property transfers incident to a divorce of for U.S. citizens or residents and for non-residents, and non citizens.

Assume a couple from the United Kingdom purchase a vacation condominium in Miami
for use on their trips to the United States. The couple decides to divorce and under their
marital settlement agreement, H has to transfer his interest in the condominium to W.
Because the transferee, W, is a nonresident alien, this property transaction is taxable at
the time of the transfer. Now assume, that a second couple, U.S. citizens own a
condominium in Miami which they use for their leisure time. The couple decides to
divorce and under their marital settlement agreement H has to transfer his interest in
the condominium to W. Because the transferee spouse is not a nonresident alien, this
property transaction is not taxable at the time of transfer.

In addition, a transfer involving a nonresident could be taxed under the Foreign Investment in U.S. Real Property Tax Act (“FIRPTA”) and subject to a withholding requirement. This withholding assures the Internal Revenue Service that any tax owed by the nonresident alien transferor will be collected. This means that the transferee would have to withhold and pay the Internal Revenue Service up to 15 percent of the “sales price” of the real real estate or the realized tax amount of the property.

There are strategies to alleviate the U.S. income tax consequences discussed above. First, one spouse could give real property to the other spouse. A nonresident donor is currently allowed an annual exclusion of $194,000 (during the 2026 calendar year) on taxable gifts made to his or her nonresident spouse. Besides the reduction of gift tax, another advantage of gifting real property to a spouse is the fact that FIRPTA does not apply and as a result there is no withholding of the 15 percent of the realized amount of the property. Another potential strategy to mitigate or avoid tax on the transfer of real property between divorcing spouses would be to utilize a tax treaty if appropriate. If the divorcing spouses are residents of a country in which the U.S. has an income tax treaty, that treaty should be carefully reviewed. In some cases, a tax treaty can be utilized to reduce or even avoid tax liabilities associated with the transfer of real estate through a marital settlement agreement. Certain tax treaties have non-discrimination clauses that might alleviate an income tax on the transfer of property incident to a divorce agreement. For example, many tax treaties that the United States has entered into contain a non-discrimination clause. Typically, non-discrimination clauses provide that the United States cannot impose more burdensome taxes on citizens of the treaty country than it imposes on U.S. citizens who are in the same circumstances.

Transmutation Agreements

Sometimes mixed status couples (a mixed status couple for purposes of this article refers to a marriage between two individuals holding different citizenships or legal immigration status) will enter into a transmutation agreement between themselves to avoid FIRPTA withholding associated with the sale of U.S. real estate. In 1980, Congress enacted Section 897 of the Internal Revenue Code (in legislation called the Foreign Investment in Real Property Tax Act or “FIRPTA”). Section 897 imposes a tax on gain realized upon the disposition of a “U.S. real property interest.”

When U.S. real estate became a popular investment with foreigners in the 1970s, the favorable tax treatment accorded foreign investors in U.S. real property became a domestic political issue. Congress responded in 1980 by enacting the Foreign Investment in Real Property Tax Act of 1980 (or “FIRPTA”), which tried to equate the tax treatment of real property gains realized by domestic and foreign investors. Prior to FIRPTA, foreign persons generally were not taxed on gains from the disposition of a U.S.real property interest. Under FIRPTA, gains or losses realized by a nonresident alien individual are taxed in the same manner as income effectively connected with the conduct of a U.S. trade or business.  This means that gains from dispositions of U.S. real property interests are taxed at the regular graduated rates, whereas losses are deductible from effectively connected income.

To ensure collection of the FIRPTA tax, generally, any transferred acquiring a U.S. real property interest must deduct and withhold a tax equal to 15% of the amount realized on the disposition. The amount realized is the sum of the cash paid or to be paid (excluding interest), the market value of other property transferred or to be transferred, the amount of liabilities assumed by the transferred, and the amount of liabilities to which the transferred property was subject.

As with withholding taxes in general, a transferee that fails to withhold is liable for any uncollected taxes. Therefore, any transferee of U.S. real property must be careful to determine whether withholding is required. To ease the withholding burden, withholding is not required in the following situations:

1. The transferee receives an affidavit from the transferor which states, under penalty perjury, that the transferor is not a foreign person;
2. The transferee receives a withholding certificate issued by the Internal Revenue Service (“IRS”), which notifies the transferee that no withholding is required;
3. The transferee receives a notice from the transferor that no recognition of gain or loss on the transfer is required because a nonrecognition provision applies;
4. The transferee acquires the property for use as a personal residence and the purchase price does not exceed $300,000; or
5. The transferee acquires stock that is regularly traded on an established securities market.

As a general rule, no withholding is required for a seller who is a U.S. person. In order for an individual to be a U.S. person, he or she must be either a U.S. citizen or a resident alien. Even if the seller is a foreign person, withholding will not be required in every circumstance. An alien is considered a U.S. resident and is not subject to withholding under FIRPTA if the alien meets either the green card test or the substantial presence test for the calendar year of the sale. An alien is a U.S. resident if the individual was a lawful permanent resident of the U.S. at any time during the calendar year. An alien is considered a U.S. resident if the individual meets the substantial presence test for the calendar year of the sale. Under this test, the individual must be physically present in the U.S. on at least: (1) 31 days during the current year; and (2) 183 days during the current year and the two preceding years, counting all the days of physical presence in the current year but only ⅓ the number of days present in the the first preceding year, and ⅙ the number of days in the second preceding year.

Mixed status couples may enter into into a transmutation agreement whereby the non-resident spouse transfers his or her interest in the real estate to the U.S. citizen or resident spouse in order to avoid FIRPTA withholding on the sale of jointly held U.S. real estate. A properly drafted transmutation agreement entered into between spouses will typically be recognized by the IRS in certain cases to avoid FIRPTA withholding. Although a properly drafted transmutation agreement can potentially be entered into between mixed status couples to avoid FIRPTA withholding, entering into an agreement to transmute the ownership interests in U.S. real property may not be enough to avoid FIRPTA withholding.  The transmutation of the ownership of the real estate should be reflected in deed to the real estate and to avoid any misunderstandings, the parties to the transmutation agreement should consider recording the transmutation agreement.

Given these complexities, any transfer of property, in particular U.S. real estate, should be reviewed in advance by a tax attorney with a strong background in international tax  to determine the exact U.S. consequences of such a transfer.

Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony has advised various Fortune 500 companies and large privately held businesses in their cross-border tax planning. Anthony is the author of a number of published articles addressing cross-border taxation. Anthony also frequently provides continuing educational programs regarding various international tax topics.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.