Foreign Investment in Real Property Tax Act 1980 – Buyer AND Seller Beware
By R. Scott Jones, Esq.
This article summarizes the tax withholding rules imposed on a buyer and his/her agent when purchasing U.S. real estate from a nonresident alien for U.S. tax purposes.
Nonresident alien individuals and foreign corporations are subject to tax on realized gain from the disposition of an interest in U.S. real property, held directly or indirectly. The gain is taxed as if it were effectively connected with the conduct of a U.S. trade or business, whether or not the foreign person is in fact engaged in a U.S. trade or business during the taxable year.
When Tax Withholding is Required
Furthermore,pursuant tothe Foreign Investmentin Real Property Tax Act 1980 (FIRPTA), the Internal Revenue Code generally requires any transferee (buyer) of a U.S. Real Property Interest (USRPI) buyer to withhold from the purchase price an amount which constitutes a tax on the foreign transfer or (seller). The normal withholding rate under Internal Revenue Code (IRC) section 1445 is 10% of the amount realized by the seller on the disposition. The amount realized by the seller is the sum of the following:
1) The cash paid, or to be paid (principalonly),
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.
There is no deduction for any expensesofsale.
This creates a problem where the sales price exceeds the amount of cash in the transaction (for instance, where the nonresident seller carries a note on the property). Owning real property through corporations also provides no escape from FIRPTA.
IRC section 1445 also states that a foreign corporation that distributes a U.S. real property interest must withhold a tax equal to 35% of the gain it recognizes on the distribution to its shareholders. This withholding requirement does not apply if the foreign corporation has elected under IRC section 897(i) to be treated as a domestic corporation.
However, a domestic corporation must withhold a tax equal to 10% of the fair market value of the property distributed to a foreign person if:
- The shareholder's interest in the corporation is a U.S. real property interest, and
- The property distributed is either in redemption of stock or in liquidation of the corporation.
Reporting and Payment to the IRS
The buyer must report and pay to the IRS any tax withheld by the 20th day after the date of the sale. In reporting and paying the withheld amount the following forms are to be used: Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests 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.
Forms 8288, 8288-A and the withholding tax must be filed (mailed) to the IRS by the 20th day after the date of transfer unless the seller is waiting for a response from the IRS to an application for a withholding certificate filed before closing occurs (see below).
In this case, upon receipt of an approved withholding certificate or rejection letter, the taxpayer has 20 days from the date on the certificate/letter to file Forms 8288 and 8288-A and remit the required amount. Penalties and interest will be charged on late filed Forms 8288 (filed after the 20th day from the date of transfer or the response from the IRS to the withholding certificate). There is a penalty of up to $10,000 in addition to the tax for a willful failure to collect and pay.
The withholding agent must prepare a Form 8288–A for each person from whom tax has been withheld. Attach copies A and B of Form 8288–A to Form 8288. Keep Copy C for your records.
IRS will stamp Copy B and send it to the person subject to withholding. That person must file a U.S. income tax return and attach the stamped Form 8288–A to receive credit for any tax withheld. FIRPTA forms are sent to the following address:
Director, Philadelphia Service
Center FIRPTA Unit
P.O. Box 21086
Philadelphia, PA 19114-0586.
Note: A real estate broker or salesperson ("broker") for either party can be held liable for the tax that should have been withheld (up to the amount of compensation received), if the broker has actual knowledge that the nonforeign affidavit is false and fails to notify the buyer and the Internal Revenue Code (IRC) section 1445. Under certain circumstances, the broker may also be liable for civil or criminal penalties.