Foreign Investment in U.S. Real Estate
USINF0 | 2013-11-01 13:18

 

What Is FIRPTA?
In 1980, the U.S. Government implemented the Foreign Investment In Real Property Tax Act (or
“FIRPTA”). The purpose of this law is to impose an income tax on the gains derived by foreign
persons from the sale of their U.S. property.
FIRPTA imposes an income tax on the sale of any U.S. real property interest . This includes
U.S. real estate owned directly by a foreign investor, as well as shares owned by a foreign person
in a U.S. corporation that owns substantial real estate.
To ensure collection of U.S. taxes that are due on the sale by a foreign investor, FIRPTA also
provides a withholding mechanism under which the buyer, who is the “transferee” of the U.S.
property, is obligated to withhold 10% of the purchase price at closing and send it directly to the
Internal Revenue Service (the “IRS”), instead of paying the full amount to the foreign seller. In
addition, a number of states, such as Hawaii, California and Colorado, also have a withholding
tax on sales of real estate located within their borders.
Who is subject to FIRPTA?
FIRPTA tax is imposed on nonresident alien individuals and foreign corporations.
FIRPTA Tax Rates:
A foreign person's gains from dispositions of their U.S. property are subject to income tax under
FIRPTA at the same graduated rates applicable to U.S. persons.
Individual Capital Gain Tax Rates: If the investor is a nonresident individual and the real estate
qualifies for capital gain treatment, the net capital gain income will generally be subject to a tax
rate of approximately 15%.
Corporate Capital Gain Tax Rates: If the investor is a foreign corporation and the real estate
qualifies for capital gain treatment, the net capital gain income is currently subject to a possible
tax rate in excess of 35%.
Ten Percent Withholding Tax:When FIRPTA applies, the transferee of the U.S. property must
deduct and withhold 10% of the "amount realized" by the foreign seller. The amount of the
seller's gain actual gain on the sale is irrelevant. The “amount realized” is usually the sales price
for the property and includes the cash paid to the seller, the fair market value of any other
property transferred by the buyer to the seller, and the outstanding amount of any liabilities paid
off. This withholding tax is treated as an advance payment against the actual Individual or
Corporate capital gains tax discussed above.
Withholding Tax Not Final Obligation: The 10% withholding tax imposed on the foreign seller
of a U.S. property is not the amount of tax actually due. It is merely an advance payment toward
the foreign seller’s U.S. income tax obligation arising from the sale of the property. The foreign
seller must file a U.S. income tax return for the year of the sale by the applicable filing deadline.
Such return will show the amount of gain derived from the disposition of the sale of the property
and the amount of U.S. income tax due on the gain. The amount of the foreign seller’s final U.S.
tax obligation, or refund, is determined by crediting the withholding tax against the amount of
income tax shown on the return.
1031 Exchanges:
Section 1031 of the U.S. Internal Revenue Code makes it possible for a foreign seller to avoid
recognizing gain on the sale of its property by “exchanging” it for another investment property.
If the exchange qualifies under U.S. law, recognition of gain for the foreign seller will be
deferred and no FIRPTA income or withholding tax will be due on the transaction.
U.S. law requires that the foreign seller use an independent third party, or “Qualified
Intermediary” to handle the exchange. All of the proceeds from the sale, including non-cash
proceeds (such as a boat that you receive in trade), must go to the Intermediary to be used for the
purchase of the new property. Any thing received directly, or indirectly, by the seller (no matter
how insignificant) will disqualify the entire transaction resulting in imposition of the FIRPTA
withholding and recognition of the entire gain.
To qualify for the 1031 exchange exemption, several requirements must be met: (1) the new
property must be located within the U.S.; (2) From the date the foreign seller closes the sale of
the old property to the buyer, the foreign seller has 45 calendar days to provide the Intermediary
with a list of properties they want to buy, (this list is called “the 45 day list” and there are
typically 3 properties or less on this list); (3) From the date the foreign seller closes the sale of
www.expert1031.com.pdfs/firpta.english.pdf - page 3 of 3
the old property to the buyer, the foreign seller has 180 calendar days to purchase one or more of
the properties on the 45 day list; (4) The foreign seller of the old property must take title to the
new property in the same legal name in which they owned the old property; (5) The foreign
seller must buy new property for an amount equal to, or greater than, the sale price of the old
property; (6) All cash from the sale of the old property, after paying closing costs and liabilities,
must go the Intermediary and be used for the purchase of the new property.
FIRPTA rules impose additional requirements into 1031 exchange rules in order to avoid the
10% withholding. One of these is that the person responsible for transferring of the old property
from the foreign seller to the buyer/transferee (such as a title or escrow company) must receive
from the foreign seller either: (1) a Withholding Certificate issued by the IRS that sanctions the
particular exchange and allows the transferee to avoid withholding any tax, or (2) notice from the
foreign seller that certifies that the seller has applied for a Withholding Certificate. A seller will
generally use IRS Form 8288-B to file an application for Withholding Certificate.
The foreign seller must provide an “individual taxpayer identification number” (“ITIN”) when
applying for a Withholding Certificate. The ITIN cannot just be ‘applied for’. The ITIN must be
assigned by the IRS and received by the seller before a Withholding Certificate application can
be filed. The instructions to the application form for an ITIN (IRS Form W-7) state that it takes
four to six weeks for the IRS to assign an ITIN. However, many tax professionals say it often
takes more than three months for the ITIN to be assigned. If the foreign seller is an entity, then
the person signing the entity’s ITIN application must also have a tax identification number. If
that person is also a foreign person, they must apply for and receive an ITIN so that they can
apply for the entity’s ITIN, which must be received before the entity can apply for a Withholding
Certificate. All of this can take considerable time.
In any event, a few general guidelines should help ensure that foreign investors are not
unwittingly tripped up by the FIRPTA restrictions. First, any foreign property owner should plan
ahead to obtain an ITIN well before transferring any property, and to apply for a withholding
certificate as soon as any property transfer has been arranged. Second, it is critical that any
foreign seller wishing to complete a 1031 exchange consult with a knowledgeable, professional,
qualified intermediary early in the sale process. Finally, any foreign seller should seek
independent legal, tax, or financial counsel from experienced advisors to assist them with the
closing and U.S. tax filing process.
A copy of the IRS forms necessary to apply for the ITIN, as well as the forms necessary to obtain
a Withholding Certificate can be downloaded from our web site.

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