BUYER’S U.S. REAL PROPERTY (FIRPTA) WITHHOLDING TAX LIABILITY
Among the documents processed in virtually every real estate transaction is a certification of non-foreign status. The purpose of this document is to protect the property buyer from liability for I.R.S. withholding tax which applies if the seller is a foreign person.
The U.S. taxes foreign persons’ U.S. real property gains in generally the same manner as U.S. persons’ gains. In order to ensure collection of a foreign person’s tax on disposition of U.S. real property, the I.R.S. imposes withholding and reporting requirements on the buyer, and to a certain extent, on professionals involved in carrying out the transaction. Under this system, although any taxable gain is earned by and thus taxable to the foreign seller, the buyer is liable for the tax if it is not paid by the foreign seller. The required withholding is 10% of the amount realized on the disposition of a U.S. real property interest.
This article focuses on the 10% withholding requirement applicable to sales of direct investments in U.S. real property.
A foreign person generally includes a nonresident alien individual, foreign (non-U.S.) corporation, partnership, trust or estate, but does not include a “resident alien” individual.
The amount realized is the gross contract price, without reduction for costs or expenses, including: 1) the cash paid or to be paid (excluding interest), 2) the fair market value of other property transferred or to be transferred, and 3) the outstanding amount of any liability assumed by the buyer or to which the property is subject immediately before and after the transfer. It is important to note that the amount to be withheld is not affected by the amount of cash paid by the buyer. For example, withholding on the full purchase price is immediately due even if payment is deferred by installment sale or like-kind exchange.
A disposition is any type of transfer including a sale, exchange, or foreclosure. Special rules and withholding rates apply for distributions or other dispositions of U.S. real property interests by foreign or domestic corporations, partnerships, trusts and estates to the extent attributed to a foreign person.
A U.S. real property interest includes ownership, a leasehold or an option held directly or indirectly (for example, through share ownership in a U.S. corporation with assets primarily invested in U.S. real property). The term “real property” includes land and improvements, an interest in a mine, well, or other natural deposit, as well as movable walls, furnishings, and other personal property associated with the use of real property (such as farming machinery), located in the U.S. or the Virgin Islands. The term excludes an interest in certain publicly traded corporations, partnerships and trusts.
Buyer’s Withholding and Reporting Obligations
It is the buyer, not the seller, who is obligated for withholding and reporting at the time of the sale. Unless the transaction is exempt from withholding as described below, the buyer must report the sale to the I.R.S. on Forms 8288 and 8288-A, and pay the required tax withholding, by the 20th day after the date of transfer. The “date of transfer” is the first date consideration is paid or a liability transferred (excluding payments before title passage such as earnest money and deposits). This deadline is extended to the 20th day after the I.R.S. accepts or denies a legitimate application for a “withholding certificate” if the application is filed on or before the transfer date.
Seller’s Tax Obligations
Prior to transfer, the seller may apply to the I.R.S. for a “withholding certificate” in order to reduce or eliminate the required amount of 10% withholding. If the deadline is missed and tax is withheld, the seller must wait until the close of the tax year before I.R.S. will consider a claim for refund (i.e., where the 10% withholding exceeds the actual tax liability). In either case, the seller must file an annual tax return for the disposition-year on Form 1040NR or Form 1120F reporting all U.S. income, claiming any 10% withholding as a prepayment of tax, and paying any balance due or claiming any allowable refund. Arizona tax filing also applies if the property is in Arizona (even though Arizona does not presently impose withholding tax, unlike other U.S. states such as California which do).
Transactions Exempt from Withholding
1. Seller’s Certification – No withholding or reporting is required if either: a) the seller is not a foreign person, or b) the subject property is not a U.S. real property interest. In either situation, the buyer may rely on the seller’s certification affirming either of the foregoing, unless there is knowledge that it is false (by the buyer or an agent of the buyer or seller). Certification that the seller is not a foreign person must be signed under penalties of perjury and set forth the seller’s name, U.S. tax identifying number and home or office address. This is by far the most commonly used exemption procedure (since most transactions do not involve foreign sellers).
2. Home Purchased for $300,000 or Less – No withholding or reporting is required if the property is acquired for the buyer’s use as a home. The buyer must have definite plans to reside at the property for at least 50% of the number of days that the property is used by any person during each of the first two 12-month periods following the date of the transfer. This exemption does not apply if the buyer is other than an individual.
3. Buyer is a U.S. Governmental Body – No withholding is required if the buyer is the United States, a U.S. state or possession, a political subdivision, or the District of Columbia.
Withholding Certificate Procedure – Application for Withholding Tax Reduction
The 10% withholding may be reduced or eliminated if a withholding certificate is obtained from the I.R.S. Either the buyer or the seller may apply for the certificate. The I.R.S. is required to act within 90 days of receiving a properly completed application and any required tax withholding is due within 20 days of I.R.S. acceptance (or denial) of the application.
The following are the most important fact patterns favorably considered by the I.R.S. A discussion of the requirements of each is beyond the scope of this article.
1. 10% withholding exceeds seller’s maximum tax liability,
2. Seller is entitled to non-recognition treatment or is exempt from tax,
3. Seller qualifies for installment sale treatment, or
4. Buyer or seller enters into a secured agreement for payment of tax.
Caveat emptor – let the buyer beware! If you are the buyer, make sure you receive a reliable exemption certification from the seller, otherwise withhold a sufficient amount of the purchase price and comply with the I.R.S. requirements. If you are an agent and have knowledge that a seller’s exemption certification is false, provide written notice to the buyer. If you are a foreign seller, determine if an exemption or reduction applies and provide notice to the buyer or apply to the I.R.S. for a withholding certificate before the transfer, and also be sure to file the required Federal (or state) income tax returns.