Foreign Investment in Real Property Tax Act 1980 – Buyer AND Seller Beware - Part 4
A withholding certificate is applied for using Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests. This form requires the description of the U.S. real property interest being sold, the sales price, a calculation of the maximum tax owed, and evidence that the seller has no unsatisfied FIRPTA withholding obligations with respect to the purchase of the U.S. real property interest. Even if a withholding certificate is obtained, the nonresident alien must file a U.S. tax return for the year of sale and pay any appropriate amount of tax due at that time or evidence entitlement to non-recognition or exclusion.
The IRS generally will act on a completed withholding certificate application within 90 days of the request (although this can depend). Alternatively, the regulations permit the seller to request an early refund of amounts already withheld if the request for an early refund is combined with an application for a withholding certificate.
A seller that applies for a withholding certificate must notify the seller in writing that the certificate has been applied for on the day of or the day prior to the closing.
If an application for a withholding certificate is submitted to the IRS before or on the date of a transfer and the application is still pending with the IRS on the date of transfer, the correct withholding tax must be withheld, but does not have to be reported and paid immediately. The amount withheld (or lesser amount as determined by the IRS) must be reported and paid within 20 days following the day on which a copy of the withholding certificate or notice of denial is mailed by the IRS.
If the principal purpose of applying for a withholding certificate is to delay paying over the withheld tax to the IRS, the seller will be subject to interest and penalties. The interest and penalties will be assessed beginning on the 21st day after the date of transfer and ending on the day the payment is made.
Sale of a Personal Residence or Like-Kind Exchange
Typical cases in which a withholding certificate may be sought are on the basis of exclusion from tax of any capital gain on real estate that qualifies as the seller’s personal residence (IRC section 121), or for like-kind exchange treatment (IRS section 1031).
For example, the application must include information establishing that the seller, who is a nonresident alien individual at the time of the sale (and is, therefore, subject to FIRPTA) is entitled to claim the benefits of section 121 by showing that the seller occupied the U.S. real property interest as his or her personal residence for the required period of time (i.e., for tax purposes, it is a “home-sale”).
In this instance, Form 8288-B expressly requests the following be attached:
- A brief description of the transfer,
- A summary of the law,
- Facts supporting the claim of non-recognition or exemption from tax
- Evidence that the transferor has no unsatisfied withholding liability, and
- the most recent assessed value for state or local property tax purposes of the interest to be transferred, or other estimate of its fair market value.
A nonresident alien or foreign corporation must also attach a statement of the adjusted basis of the property immediately before the distribution or transfer.
When a seller exchanges a U.S. real property interest, and the exchange qualifies for non-recognition treatment, the seller must draft a notice of nonrecognition in accordance with IRC section 1445 and include on the notice the seller’s TIN, name and address. The seller must present this notice to the buyer before the date of sale. The buyer must mail the notice of nonrecognition to the IRS no later than 20 days from the date of the exchange. If the notice of non-recognition does not contain the seller’s TIN, name and address, then the seller cannot rely on the notice and is required to withhold tax.
Understanding the application of exclusion and non-recognition provisions to a seller’s tax treatment is key to understanding the merits of any withholding certificate application and, therefore, the obligation on the buyer to withhold tax.
For example, the home-sale gain exclusion rule generally allows a taxpayer to exclude from income gain realized from the saleor exchange of property if, during the five-year period ending on the date of the sale or exchange, such property was owned and used by the taxpayer as the taxpayer's principal residence for a period aggregating two or more years. The amount of the exclusion from gross income is generally limited to $250,000 ($500,000 for certain married taxpayers filing a joint return).
To be eligible for the home-sale gain exclusion, a taxpayer must have owned the residence and occupied it as a principal residence for at least two of the five years prior to the sale or exchange. A taxpayer who fails to meet these requirements due to a change in place of employment, health, or other unforeseen circumstances may exclude the fraction of the $250,000 amount ($500,000 for certain married taxpayers filing a joint return) equal to the shorter of: (1) the aggregate periods during which the ownership and use requirements were met during the five-year period ending on the date of sale or exchange bears to two years; or (2) the period after the date of the most recent sale or exchange to which the home-sale gain exclusion applied bears to two years. In such circumstances, the requirement that the exclusion provision apply no more than once every two years is ignored. The pro-ration is on the basis of either the number of days (using 730 as the denominator) or the number of months (using 24 as the denominator).
Clearly, the normal rules do not apply in the context of cross-border moves and investments and require careful examination.
Lastly, it is important to ensure that the seller’s tax return reporting the disposition of the real estate reflects facts and contained in the application for any withholding certificate and/or that procedures are followed for obtaining appropriate credit for any withholding taxes paid at closing.
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In summary, FIRPTA provisions present a host of issues that require early and specialized attention to ensure the real estate closing occurs as smoothly as possible. Lawyers and real estate brokers representing both sellers and buyers need to be aware of these provisions and act accordingly.
Copyright ©October 2006, GOLDSTEIN JONES LLP