The purpose of this bulletin is to highlight various tax aspects of The Foreign Investment in Real Property Tax Act and provide guidance for handling applicable real estate transactions. Generally, Section 1445 of the IRS tax code provides that a transferee (buyer) of a U.S. real property interest must withhold tax if the transferor (seller) is a foreign person. However, there are exemptions to the withholding requirement.
WHO IS CONSIDERED A FOREIGN PERSON?
Foreign persons, as defined by the Act, include the following:
A resident alien, with a green card is NOT a foreign person and FIRPTA does not apply.
U.S. real property interest owned jointly by foreign and non-foreign transfers:
First, allocate the sales price among the transferors based on capital contribution, then, aggregate the amount allocated to any foreign person.
NOTE: The IRS treats a husband and wife as having contributed 50% each.
WHAT IS THE WITHHOLDING REQUIREMENT?
If FIRPTA applies, 10% of the gross sales price must be withheld and remitted to the IRS within 20 days of closing, using form 8288 and 8288-A. The 10% is merely a deposit which is applied to any actual tax liability the seller may have for the year of the sale. The BUYER is considered the "statutory withholding agent" for the IRS, responsible for determining whether FIRPTA applies and remitting to the IRS. Failure to comply can expose the buyer to tax liability, including interest and penalties. In addition, the title agent, as a "Qualified Substitute" responsible for handling the transaction, may also have liability.
WHAT ARE THE EXCEPTIONS TO WITHHOLDING REQUIREMENT?
If an individual seller furnishes the buyer with a Non-Foreign Person Certification (Individual Transferor), then no withholding will be required.
If a foreign corporation that has elected to be treated as a domestic corporation and furnishes the buyer with a Non-Foreign Person Certification (Entity Transferor), then no withholding will be required.
Disregarded Entity: A disregarded entity (single member LLC) will not be considered a transferor but rather its OWNER will. A Non-Foreign certification from a single member LLC will not be effective if the member is a non-resident and FIRPTA will apply unless the LLC elected to be treated as a domestic partnership or corporation.
NOTE: Non-Foreign Certifications are not effective if you have actual knowledge or receive notice that they are false.
If the sales price is $300,000 or less, an individual Buyer may elect to execute an "Intent to Reside" thereby eliminating the withholding requirement. The Intent to Reside is a statement that the buyer or a family member intends to occupy the property for at least 50% of the time the property is used by any person during each of the first two 12-months following closing. There is absolutely no obligation for the buyer to sign the Intent to Reside, inasmuch as failure to comply with the occupancy requirement could expose the Buyer to additional risk. The buyer has the sole discretion whether to rely on this exception.
A foreign seller can apply for an exemption from the 10% withholding by applying for a Withholding Certificate (Form 8288-B) from the IRS PRIOR to the closing date. The agent can then escrow the 10% until such time as the IRS grants relief. The turnaround time for an IRS determination could exceed six months. If the application for a withholding certificate is submitted without an individual tax identification number, the IRS will reject the application outright. The IRS will issue a letter stating they have rejected the application and the 10% must then be remitted within 20 days of the rejection letter. Consequently, unless the seller can provide verification the application for withholding certificate has been filed and accepted by the IRS, you should remit the funds to the IRS.
DOES FIRPTA APPLY TO SHORT SALE TRANSACTIONS?
Although there are usually no proceeds flowing to a seller in a short sale transaction, the 10% withholding requirement nevertheless applies. Therefore, it becomes crucial to identify a FIRPTA transaction as soon as the contract is submitted for processing. Since it takes months if not longer from contract to closing a short sale transaction, the seller may have sufficient time to apply and receive a Withholding Certification from the IRS prior to closing.
SALES INVOLVING A FOREIGN DECEDENT ON TITLE
The Internal Revenue has special rules if a foreign person was on title at the time of death. A federal estate tax lien will exist until such time as the IRS issues a "Transfer Certificate", a federal estate tax return is filed AND the IRS issues a "Closing Letter" for the estate. Keep in mind, a foreign decedent only receives a $60,000 exemption from the federal estate tax, unlike the $5 million exemption for a U.S. decedent. The buyer, realtor and closing agent are all potentially liable to the IRS for any tax shortfall as "Statutory Executor" if the funds for closing were at any time under their control. Once the IRS issues a Transfer Certificate, the transaction can close but funds cannot be disbursed to the beneficiaries of the estate until the IRS has "closed" the estate, which can take 12-15 months after the estate tax return is filed.
The requirement for obtaining a Transfer Certificate also applies to title held by husband and wife if the decedent spouse was foreign. Although title may automatically pass to the surviving spouse under state law, the federal tax lien under the IRS Code is not relieved until a Transfer Certificate is obtained. The same holds true for the survivor of jointly held property with rights of survivorship where the decedent joint tenant was foreign.
FIRPTA transactions require additional care and expertise. The above are some basic guidelines to assist in closing these special transactions. The goal is to provide exemplary service to your customers while avoiding unnecessary liability.