What is FIRPTA?
When a foreigner is selling a piece of U.S. Real Property, the IRS withholds 10% of the total gross selling price known as a FIRPTA tax, or the Foreign Investment in Real Property Tax Act. While this is not a final tax, it is a withholding of tax on account that is withheld at the closing table. For example, if a foreign seller sold a piece of real property for $200,000, the IRS would impose a 10% tax of $20,000 at closing.
Why does the IRS do this? We know that the IRS sees a sale as a taxable event. During the sale of a property, the capital gains tax is paid with the filing of the taxpayer’s tax return. For many foreigners though, tax returns are not usually filed until the end of the calendar year. By withholding tax on the sale of their U.S. property through FIRPTA laws, the U.S. government is forcing foreigners to file their tax returns in order to get back that withholding. Once a foreigner files their tax return, they will typically see a pretty hefty refund. Should they choose not to file their tax return, they risk losing the 10% that was withheld at closing. For many folks, that’s a lot of money!
How are FIRPTA Laws Changing as of February 16, 2016?
Effective as of February 16, 2016, the IRS will be increasing that percentage withheld by FIRPTA from 10% to 15%! Let’s go back to our previous example. If a foreign seller sells a piece of real property on or after February 16, 2016, they will now have 15% withheld. If they sold their property for $200,000, the IRS would now withhold $30,000 at closing. That’s a big jump!
How Can a Foreign Seller Avoid the Withholding of FIRPTA Tax?
For a foreign seller looking to sell their U.S. real property, the 15% FIRPTA tax can be a huge inconvenience. Luckily, there are a few exceptions and reliefs to help them get around that.
If the selling price is $300,000 or less and the buyer or their immediate family intends to use the property as a residence for at least 50% of the time occupied during the next two 12-month periods following the date of the sale, the FIRPTA withholding tax can be avoided. An affidavit would be signed by the buyer as proof they are purchasing for $300,000 or less and using for personal using according to the regulations of section 1.1445-2(d)(1).
If the selling price is greater than $300,000 and less than $1,000,000, the buyer will sign the personal use affidavit (mentioned above), and FIRPTA tax would be reduced from 15% to 10%, providing some relief to the foreign seller.
A foreign seller can also choose to apply to the IRS for relief from withholding by filing form 8288-B, Application for Withholding Certificate, which requests a reduced withholding if the sell can show the approximate tax on the gain is less than the 15% FIRPTA required.
The 50% Personal Use Occupancy Test
This is a test developed by the IRS which measures how much time the property will be “occupied” by the owner. It is not a “time only” test. The total time occupied means the total days that people resided in the property. For example, if the owner resides in the property 90 days of the total 365 days in a year with the remaining days of the year unoccupied, this means the owner resided in the property 100% of the time occupied. If in addition to occupying the property 90 days of the year, the owner rented the property for 60 days, then the owner occupied the property 60% of the time occupied (90/150), and therefore can sign the affidavit.
How Can 1031 Exchange Connection and Nace Cohen, CPA Help with your Foreign Client’s Needs?
For your foreign clients, we are their true one-stop shop to help with all of their needs regarding foreign taxation. Our qualifications as CPA’s and as a Certified Acceptance Agent allows us to apply for ITIN’s for Non U.S. Residents, apply for withholding certificates, and prepare required non-resident tax returns. In addition, we also do their 1031 Exchanges. We are able to save many foreign clients from wasting time, added stress, and many unnecessary headaches by simply just coming to us for their foreign taxation needs!
To read the new FIRPTA instructions, effective as of February 2016, please go to https://www.irs.gov/pub/irs-pdf/i8288.pdf