When are foreigners not subject to FIRPTA
Sunday, January 29, 2006 at 10:28AM This question has come up twice in two weeks so I thought I would memorialize it here. Part of my practice is helping foreigners navigate the tangle of laws and regulations associated with buying and selling US real estate. In 1980 congress passed the Foreign Investment in Real Property Tax Act, better known in tax circles as FIRPTA. One of the most prevalent aspects of FIRPTA is the required 10% withholding when a foreign non-resident sells US real estate. Ten percent of the sales proceeds must be withheld at closing and sent to IRS. This is to make sure that the seller files a US tax return in the year of sale to report gain and pay the associated tax. But withholding is not always required.
In this area many long time real estate agents have come across FIRPTA and most title companies are pretty familiar with it. However, the number of real estate professionals in this area has exploded in the last four years so it's not surprising that some people are being given bad advice by those with less experience. There are several exceptions to FIRPTA withholding but I see three most often.
The first exception occurs if a buyer purchases a residence for less than $300,000 from a foreign seller. If the buyer or the buyer's family intends to reside in the property for at least 50% of the days it will be occupied over the next two years no withholding is required. The thing to remember here is that the seller is the one who stands to have 10% withheld and most buyers are reluctant to sign anything with tax implications just so it will save the seller some time and expense. Note that this does not exempt the seller from filing a tax return reporting gain on the sale. It just means that no money is withheld at closing.
The second exception occurs when the seller obtains a withholding certificate from IRS. This is a request for IRS to reduce the amount that must be withheld. For instance if a foreign seller will realize $100,000 of long term gain on a $500,000 home sale there will be $15,000 of capital gains tax owed (15% of 100,000). However, the 10% FIRPTA withholding amount is $50,000. The seller applies for a withholding certificate to reduce the withholding to $15,000. This request usually occurs just before closing. If the request is not approved by the closing date then the whole $50,000 is held in escrow until IRS responds. When the request is approved the seller will receive $35,000 from the escrow account, but must still file a tax return for the year of sale. Withholding certificates can take three to four months to get approved so if the sale occurs toward year end it is usually easier to allow the larger amount to be withheld and get the difference back as a tax refund early the next year.
The third big exception occurs with sellers who are "resident" foreigners. IRS has a 183 day test to determine how foreigners are taxed. Using a formula IRS weights your presence in the US during the last three years. The formula works by taking the days present in the most recent tax year, one-third of the days from the first preceeding year, and one-sixth of the days from the second preceeding year. If the total is greater than 183 you are taxed like any other US citizen. If the number is less than 183 you are taxed as a non-resident alien. Non-resident aliens are subject to FIRPTA, resident aliens are not. There is a misconception among some real estate professionals that if you don't have a US passport you must be subject to FIRPTA, but this is not the case. The seller can provide a written statement to the buyer meeting certain requirements and the FIRPTA withholding requirement will not apply.
Once you deal with these rules in real life situations they are not difficult to understand and apply. However, if no one on the 'closing team' is familiar with FIRPTA the area can be a minefield. Interestingly, the buyers in these situations are often placed in the greatest risk. If withholding is not done properly IRS can look to the buyer for any missing tax. If this happens an ugly fight results between the buyer, the title company, the real estate agent and possibly the seller if still present in the US. The advice as always is to work with people who know what they're doing. If you need referrals to knowledgable real estate agents familiar with FIRPTA give me a call.
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Reader Comments (2)
We are New Zealand citizens and are looking into investing farmland in Kansas, would any capital gains be taxed at 30% above what a US citizen would pay due to the effect of FIRPTA
Tom,
The US taxes long term capital gains at a rate of 15%, whether you are a citizen or not. FIRPTA withholding just requires that 10% of the proceeds be withheld at sale, but it does not increase the rate of tax on the capital gain.