By Anthony Diosdi
When a U.S. income tax nonresident alien or a foreign corporation (hereinafter referred to as a “Foreign Taxpayer”) disposes of a U.S. real property interest (“USRPI”), the Foreign Taxpayer is subject to the Foreign Investment in the U.S. Real Property Tax Act of 1980 (“FIRPTA”). FIRPTA is designed to ensure that a foreign investor is taxed on the disposition of a U.S. property interest. The term “disposition” means transfer. To ensure collection of FIRPTA, any transferred acquiring a U.S. real property interest must deduct and withhold a tax on the amount realized on the disposition. A transferee is any person, foreign or domestic, that acquires a U.S. real property interest by purchase, exchange, gift, or any other type of transfer. See Treas. Reg. Section 1.1445-1(g)(4). The amount subject to withholding is the sum of cash paid, the market value of the property transferred, or the amount of liabilities to which the transferred property is subject. See Treas. Reg. Section 1.1445-1(g)(5). The withholding rate is generally 15 percent of the sales price of the real property.
If the real property being sold or transferred is commercial property, the foreign seller or transferor is subject to a 15 percent withholding tax. If the real property being sold or transferred is residential real estate is $300,000 or less, then the withholding tax is not required. If the sales price is equal to or greater than $300,001, but equal to or less than $1 million then the seller may qualify for a reduced withholding in the amount of 10 percent. If the sales price for the residential real estate is greater than $1 million, then the withholding rate is 15 percent. To qualify under the personal residence exemption, the transferee or certain members of the transferred’s family (lineal descendants) must intend to reside at the real property at issue for more than 50 percent of the number of days that the property is used by any person for residential purposes during each of the two years following the purchase. See Treas. Reg. Section 1.1445-2(d)(1).
If the sales price of U.S. real estate is equal to or greater than $300,001, but equal to or less than $1 million then the seller would qualify for reduced withholding in the amount of 10 percent (instead of 15 percent). If the sales price is greater than $1 million, then no exception applies, and the buyer is responsible for withholding 15 percent of the amount realized by the seller.
The purchaser of a U.S. real property from a non-U.S. person or entity is, in general, required to withhold 15 percent of the purchase price, which can be claimed by the foreign investor as a credit against U.S tax liability associated with the disposition of the property. In some cases, a foreign investor can apply to the IRS for a certificate authorizing a reduced amount of withholding tax (for example, if the 15 percent withholding tax exceeds the maximum amount of tax payable on the disposition of the property).
FIRPTA Withholding Procedures
If FIRPTA withholding is required, there are a number of procedures that must be followed. As with withholding taxes in general, a transferee that fails to withhold is liable for any uncollected taxes. Along with withholding, a transferee or buyer has an obligation to file with the IRS Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests for each foreign investor disposing of real property located in the U.S. These forms must be filed with the IRS no later than the 20th day after the date of the transfer.
From the foreign seller’s perspective, the withholding amount is usually greater than its U.S. federal income tax liability. The foreign seller has two options. First, the nonresident can have the transferee or buyer withhold the 15 percent. The nonresident can then file a U.S. federal tax return and request a refund for any overpayment of taxes. The foreign investor’s other option is to file a Form 8288-B with the IRS on or before the date of the transfer. Although the transferee or buyer will still need to withhold 15 percent of the amount realized in escrow, the purchaser does not need to report or pay over these monies to the IRS until the 20th day following the sale or transfer of the real property. In the meantime, the transferor or seller of the property can file a Form 8288-B and request a withholding certificate to reduce or eliminate withholding on the disposition of the real property. A transferor or seller can request a reduction in the FIRPTA withholding based on:
1) a claim is made that the transferor is entitled to nonrecognition treatment or is exempt from tax (i.e. a tax treaty reduces or eliminates the U.S. tax on the disposition of the real property);
2) A claim is made solely on a calculation that shows the transferor’s maximum tax liability is less than the tax otherwise required to be withheld; or
3) A claim is made that special installment sales rules which are described in Section 7 of Rev. Proc. 2000-35 are permitted in the disposition of the real property to reduce withholding. In the past, the IRS would normally act on a Form 8288-B submission within 90 days of receipt of all information. These days, the processing time of a Form 8288-B can be much longer. In order to avoid unnecessary withholdings, the Form 8288-B should be submitted to the IRS as early as practically possible. The Form 8288-B must be accurately completed in order to avoid a rejection of the application. At a minimum, the following information will be necessary to properly complete the Form 8288-B:
1. The name of the transferor of the property and the identification number of the transferor.
2. The name or names of the party or parties transferring the property and the identification number.
3. A full description of the property being transferred (for example, “10-story, 100 unit apartment building).
4. The sales price of the property being transferred and the adjusted basis in the property.
5. It is necessary to tell the IRS whether or not tax returns for the three preceding tax years were filed. The definition of U.S. income tax returns includes Form 1120-F that is required to be filed by foreign corporations that have a direct or indirect interest in the U.S. property.
6. It is necessary to state on the Form 8288-B the maximum U.S. tax liability for the sale of the property. The maximum U.S. tax liability can be determined through the contract for the sale of the property, invoices for improvements to the property, and depreciation schedules on previously filed tax returns. Special rules apply under Rev. Proc. 2000-35, Section 4.06 for net operating losses. Documents used to determine the maximum U.S. tax liability may also need to be submitted to the IRS with the Form 8288-B.
7. If a reduction in the withholding is requested under a U.S. income tax treaty, the provision and an explanation must be submitted with the Form 8288-B.
The Form 8288-B must be signed under penalties of perjury by the nonresident transferor or a responsible corporate officer. The Form 8288-B may also be signed by an authorized agent such as an attorney admitted to practice before the IRS.
The IRS’s Ability to Assess FIRPTA Liability
In certain circumstances, a foreign taxpayer may wish to exchange a USRPI for another USRPI, e.g., in a “like-kind exchange” of U.S. investment real property for similar U.S. These type of transactions are generally considered “non-recognition” events for U.S. tax purposes.
Regardless of the non-recognition treatment for general U.S. tax purposes, it is imperative that the Foreign Taxpayer timely provide the transferee of the USRPI with a non-recognition statement, and by the 20th day after the date of the transfer, the transferee must file a copy of the statement with the IRS. The non-recognition statement puts the IRS on notice that a transaction has occurred in which there has been no recognition of gain or loss. If the non-recognition statement and the relevant procedures are not timely filed, and notwithstanding the general non-recognition treatment of the USRPI disposition under U.S. tax law, the IRS can impose interest on 15 percent withholding that was due when the original transaction occurred.
For example, suppose a foreign investor has investment land in the United States worth $1 million and the foreign investor exchanges the investment land for like-kind investment land having a similar value. Even if the foreign investor would have recognized gain if it had sold its investment land (assuming, for instance, the foreign investor had a tax basis in the land of less than $1 million), the like-kind exchange will result in non-recognition treatment to the foreign investor. The same result would follow if the foreign investor transferred the investment land with a value of $1 million and a lesser tax basis to a U.S. company solely in exchange for the shares of such U.S. company. In absence of properly following the non-recognition statement filing procedures, 15 percent of the investment land’s value, or $1 million x 15% = $150,000, would have to be forwarded to the IRS within 20 days of the transfer and the IRS has the authority to impose interest on such $150,000 regardless of whether or not tax is or is not due as a result of the non-recognition provisions.
The foreign investor sometimes assumes that because a non-recognition transaction results in no U.S. income tax, nothing additional must be done. These foreign investors could be in for a very unpleasant surprise when they are assessed an interest charge on the failure to withhold 15 percent in the absence of properly following the non-recognition statement procedures. Such a foreign investor could be liable for the 15 percent FIRPTA withholding tax along with interest and late payment penalties. The same fate awaits an “unwary” buyer of real property from a foreign individual who fails to properly withhold and pay FIRPTA withholdings to the IRS. The IRS could hold the buyer liable for the FIRPTA withholding tax along with interest and late payment penalties.
If you have been assessed a FIRPTA liability, you should consult with a qualified international tax attorney.
Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. 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.