Home sellers who are foreign persons and buyers who are purchasing a home from a foreign person or entity need to understand the Foreign Investment in Real Property Tax Act (FIRPTA), a federal law that requires tax withholding when real estate is sold. This law allows the U.S. to tax foreign persons on the sale of real estate interests in the United States, which may include anything from a home or land to shares of certain U.S. corporations considered real property holding companies.
This law is designed to make sure the government receives taxation on gains on the sale of real estate.
What Is FIRPTA?
The Foreign Investment in Real Property Tax Act (FIRPTA) is a federal law that governs withholding and taxation when foreign persons sell real estate in the United States. According to the Closing Agent, the act requires the purchasers to withhold a portion of the purchase price from the amount given to the seller whenever a foreign individual sells US real property. This withholding allows the US to tax the foreign individual on their sale of their property and encourages the person to file a US tax return, just like when a US citizen or resident sells their property. This federal law requires buyers to withhold a percentage of the sale price as a “deposit” that must be remitted to the IRS. There are exemptions to this withholding, however.
Note that the FIRPTA withholding is not actually a tax. It’s merely a withholding or a deposit. The seller must still file an income tax return to report the sale. This tax return is how the seller will receive back any cleared funds if the amount owed is less than the withholding.
FIRPTA Withholding Rates
When real estate is sold by a foreign seller, with some exceptions, FIRPTA requires that the buyer withhold 10% or 15% of the property’s gross sales price. This is remitted to the IRS as a “deposit.”
As of 2016, the buyer must withhold 15% of the home’s gross sales price when the property is not being purchased as a primary residence, or the total sales price is more than $1 million. Otherwise, the 10% withholding will apply. For a $300,000 home, the withholding would be $45,000, for example.
The FIRPTA withholding was increased from 10% to 15% for many transactions in 2016 under the PATH Act of 2015. The original 10% withholding only applies now to sales where the amount realized is $1 million or less and the buyer signs an affidavit that the intention is to use the home as a personal residence. The Act did not change the common exemption from FIRPTA withholding when the amount realized is no more than $300,000 and the buyer signs an affidavit to use the home as a personal residence.
Who Is Subject to FIRPTA Withholding?
FIRPTA applies only to sellers who are considered a “foreign person.” This usually refers to people who are not U.S. citizens or permanent resident aliens. A foreign person may be defined as a:
- Non-resident alien
- Foreign corporation
- Foreign partnership
- Foreign estate
- Foreign trust
Non-U.S. citizens can be exempt from FIRPTA by meeting the green card test or substantial presence test. A non-citizen who has a green card or has had one in the past calendar year passes the green card test and will be classified as a resident alien under FIRPTA. Someone who has lived in the United States for more than 31 days in this calendar year and at least 183 days over the last three years passes the substantial presence test and will also be classified a resident alien and not subject to FIRPTA.
Are There Ways to Avoid FIRPTA Withholding?
There are only a few exemptions to FIRPTA withholding. Despite common misconception, a seller who is taking a loss on the home doesn’t have an automatic exemption from FIRPTA withholding. If a foreign seller believes they are exempt from FIRPTA withholding, they can apply for a Withholding Certificate from the IRS for an exemption on the transaction. This should be done as early as possible, however.
Sales Price Under $300,000 for a Personal Residence
The most common exemption is when the sales price of the home is no more than $300,000, and the buyer intends for the home to be their personal residence. To qualify for this exemption, the closing officer will require that the buyer sign an affidavit that the home is intended for the buyer’s personal residence at least half of the time it will be occupied for the first two 12-month periods right after closing. This vital exemption won’t happen automatically. The buyer must agree to sign the affidavit and not all do. If the affidavit isn’t signed, withholding is necessary.
While this is the most common exemption to FIRPTA, there are two other cases in which withholding will not be required.
An uncommon scenario to avoid FIRPTA is through a 1031 exchange. With a 1031 exchange, a foreign investor can sell a property, reinvest the proceeds of the sale in a new property, and defer capital gain taxes. Under current rules, the following must occur for a 1031 exchange to be exempt:
- Closing on the property must co-occur with the purchase of the new property.
- There can be no mortgage boot or debt in the exchange.
- The seller must notify the buyer that the seller isn’t required to recognize loss or gain
- The buyer must provide a copy of the non-recognition notice to the IRS within 20 days
It is possible to complete a 1031 exchange if there is a mortgage on the property, although it does make the transaction more complicated. If there is a mortgage, the exchange must be evenly balanced which means:
- The seller must buy a replacement property with a purchase price greater to or equal to the value of the existing property
- The amount of mortgage debt on the relinquished property must be replaced with debt that is greater or equal to the new property
- All proceeds of the sale must be exchanged
Withholding Certificate Issued to Seller
A foreign home seller can avoid FIRPTA withholding if they have been issued a “Withholding Certificate” by the IRS. This certificate can reduce or eliminate the amount that must be withheld by the buyer. The home seller, the buyer, or the buyer’s agent may request a Withholding Certificate from the IRS through Form 8288-B in which case the IRS will approve or deny the application within 90 days. While waiting for a response from the IRS, the buyer will still need to withhold, but the buyer can wait for a response from the IRS before remitting the funds. When the buyer hears back, he or she must send the required withholding to the IRS within 20 days.
Foreign sellers can only apply for and receive a Withholding Certificate if the ultimate tax liability is likely to be zero or below 15%.
Who Is Responsible for FIRPTA Withholding?
FIRPTA only applies to real estate transactions when a seller is a foreign person, but it’s the buyer who is responsible for making sure the seller pays any capital gains taxes due. This means the seller must execute the proper forms with the seller’s name, address, and ITIN. If the buyer does not handle the FIRPTA withholding and the seller leaves the United States without paying the tax, the buyer will be responsible for paying the 15%. If the buyer does not make the payment, the IRS can seize the property or other assets. Buyers have the responsibility to determine if the seller is a foreign person and subject to FIRPTA withholding.
The FIRPTA withholding is not taken from the buyer’s funds, however; it’s a charge for the seller only.
How Long Does the Seller Need to Wait to Get Money Back?
Under United States tax law, a non-resident alien who sells interest in real estate in the United States is subject to tax withholding. Once remitted to the IRS, the funds will be held until the IRS determines that all taxes owed by the non-resident have been paid. A non-resident seller can apply for a refund from the U.S. by doing either of the following:
Filing a U.S. tax return for every year that rental income was received. All expenses and income must be reported, and the seller must file a final U.S. tax return for the year after the property is sold to report the sale and recover the balance for the cleared withholding funds. Depending on when the home is sold, this process can take up to 18 months.
File previous year tax returns when necessary along with an application for early release of the cleared withholding. This must be done on or before closing on the home. With this submission, the FIRPTA withholding will stay with the closing agent while the IRS processes and issues a Withholding Certificate for the cleared funds. This usually takes up to 90 days. Once the Certificate is issued, the title company releases the cleared funds to the seller.
Even when a Withholding Certificate is issued, the seller must still file a final income tax return. This must be done to report the sale.
Before closing, it’s essential to get the buyer’s name, address, and either the Social Security number for citizens or ITINs for non-residents to speed up the release of the fund.
What if the Buyer Is a Non-Resident?
If the buyer is also a foreign non-resident, they will need to have an ITIN or a completed W-7 form with an authenticated copy of their passport. FIRPTA withholding still applies to the transaction and other rules still apply. Non-resident buyers should ensure that FIRPTA is satisfied during closing. The settlement statement before closing should show 15% of the sales price has been withheld from the seller’s side.
Necessary Steps to Comply with FIRPTA
Meeting FIRPTA requirements in a real estate transaction usually aren’t complicated, although it does introduce complications to the transaction. The following are the steps that must be taken when FIRPTA applies, depending on the situation.
Property Priced Over $300,000:
- When the property sells for more than $300,000, the following must take place:
- If the foreign seller has an ITIN or tax ID number, a check for 10% or 15% of the sales price, the Form 8288 signed by the buyer, and a copy of the HUD-1 statement must be sent to the IRS within 20 days.
- When the seller does not have an ITIN, they must fill out a W7 with an IRS-approved acceptance agent and bring the original form to the title agent. The form, a check for 10% or 15% of the sale price, a signed Form 8288 from the buyer, and the HUD-1 statement must be sent to the IRS within 20 days.
Property Priced at $300,000 or Under:
- It is not necessary to withhold 10% if the seller is a non-resident alien as long as the buyer signs an affidavit that states the purchase price of under $300,000 and that the property will be their personal residence.
- If the buyer does not sign the affidavit, 10% must be withheld, and the funds must be sent to the IRS. The transaction will proceed as with a property that sells for more than $300,000.
For 1031 Exchanges:
- Determine if FIRPTA applies to the transaction. Sellers should find out if they are considered a foreign person selling real estate in the U.S.
- Explore possible exceptions to FIRPTA withholding that may apply.
- Foreign persons must obtain an ITIN from the IRS before selling. This can be done by filing Form W-7 as an individual or Form SS-4 as a business.
- Apply for a Withholding Certificate by filing Form 8288-B. It may be possible to apply for an ITIN and Withholding Certificate at the same time.
- The seller must notify the buyer of the relinquished property for which a Withholding Certificate has been applied.
- Before closing, a qualified intermediary can prepare the exchange documentation and forward it to the closing officer.
- The exchange will begin at the same time as closing on the relinquished property. The buyer must file Form 8288 and 8288-A to report and pay the withholding.
Author Harper Harmon is a freelance writer and blogger who focuses on business, health and other various topics. She graduated with a bachelor’s degree in communication from UCLA and currently resides in Santa Cruz with her dog, Sassy.