When a Foreigner, or Nonresident of the United States, is in the process of selling their U.S. Real Property, a withholding tax of 10% of the gross selling price is imposed by the IRS. This is known as the "FIRPTA tax", an acronym for the Foreign Investment in Real Property Tax Act. It is important to note this is not a final tax, but a withholding of tax on account. On February 16, 2016, the IRS lifted the FIRPTA tax rate up to 15%!
Withholding is required because when property is sold, it is considered a “taxable event”, and the capital gains tax must be paid with the filing of the taxpayer’s tax return. The issue is the tax return is not due until the taxpayer’s year has ended, which for most foreigners is the end of the calendar year. Therefore, the IRS withholds an estimate of the tax through the FIRPTA laws, forcing the foreigner to file a tax return come the end of the year. The FIRPTA tax that was withheld from the sale is deducted from the final tax, and the foreigner is usually issued a hefty refund. If the foreigner does not file a tax return, they risk losing that potential pot of gold.
The FIRPTA tax withholding can be avoided up front if the selling price is $300,000 or less and the buyer or his immediate family intends to use the property as a residence at least 50% of the time occupied during the next two 12-month periods following the date of sale. In practice, an affidavit is signed by the buyer as evidence they are purchasing the property for $300,000 or less and for personal use according to the Regulations section 1.1445-2(d)(1).
If the selling price is more than $300,000 and up to $1,000,000, and the buyer will sign the personal use affidavit stated above, the FIRPTA can be reduced from 15% to 10%, providing some relief to the foreign seller from the mighty FIRPTA withholding.
If the FIRPTA is imminent to the foreign seller in any event, they can apply to the IRS for relief from the withholding on form 8288-B, Application for Withholding Certificate, which requests a reduced withholding if the seller can demonstrate the approximate tax on the gain is less than the 15% FIRPTA required.
In order to apply for the withholding certificate, the seller should be prepared for the following:
1. Application for IRS Individual Taxpayer Identification Number (Form W-7) along with a certified copy of original passport or other identifying document copy as certified by the issuing agency. Be aware if there is more than one foreign property owner, a separate W-7 is needed for each property owner. If the seller already has an ITIN, this step is not necessary. A Certified Acceptance Agent (CAA) in the U.S. can assist with this process, and fees vary to the CAA for preparation for the ITIN.
2. Signed Form 2848, Power of Attorney and Declaration of Representative. This form allows the advisor, usually a CPA or Attorney, to work with the IRS with respect to the tax identification number and/or the withholding certificate.
3. Copies of the closing statement, called a HUD-1, from the original purchase. In cases where the original HUD-1 is not available, the advisor may be able to obtain purchase information, if available, on the County's public records website, such as a recorded deed.
4. Copies of all invoices of major improvements. If not available, then improvements may not be considered. It is important to find such documentation for the preparation of the final tax return.
5. Copy of the sale contract signed by both parties.
6. If doing a 1031 exchange, a copy of the exchange agreement with intermediary.
7. Name, address, and tax identification number of withholding agent (this is the buyer but, in practice, the title company is responsible for handling all the paperwork and sending the 15% FIRPTA money to the IRS).
Example with a closing date of February 15, 2016:
|| $ 600,000
|FIRPTA withholding tax (15%)
|Original purchase price
|| $ 500,000
|| $ 80,000
|Tax (20% tax rate for simplicity)
|| $ 16,000
The withholding certificate will request a reduced withholding of $16,000 vs. the $90,000 FIRPTA withholding tax, resulting in an immediate savings of $74,000 being returned to the foreign seller.
The withholding certificate must be mailed to the IRS on or before the closing date. The IRS is currently taking 6 to 12 weeks to process, and the closing agent will escrow the 15% withholding. Once approval is received from the IRS, the closing agent or attorney will release the funds. In the case above, that would be $16,000 to the IRS and $74,000 returned to the seller.
All nonresidents who sell U.S. real estate must file Form 1040NR (U.S. Nonresident Alien Income Tax Return), even if FIRPTA tax was paid. The FIRPTA tax, whether or not reduced by the withholding certificate is NOT the final tax. Form 1040NR must be filed to report the sale of the transaction. The tax return is due by June 15 following the year of the sale.
If the seller is planning on deferring the gain on the sale by doing a 1031 exchange, a withholding certificate can be applied for to reduce the withholding to zero. In this case, the IRS usually will approve the application if all the 1031 exchange documents are included with the application.
Depending on the sale date, it may not be beneficial to prepare a withholding certificate, even though the tax on the gain is significantly less that the FlRPTA tax. In the example above, it would be worthwhile to prepare the withholding certificate because the closing date is February 15, 2016. If the withholding certificate is approved by the IRS by May 15, 2016, the seller will receive the remaining $74,000 soon after the approved withholding certificate is received.
If a withholding certificate is not applied for, $90,000 is sent to the IRS within 20 days of closing. In this case, the earliest the taxpayer would be able to file a tax return for 2016 and claim a refund would be early February or March of 2017. It would take from 6-8 weeks to process the tax return, and the refund may not be received until May 2017, about a year or more from filing the application. If these funds are needed, the seller may be in a tight cash situation. However, assuming the closing date is November 15, 2016 instead of February 15, 2016, the approved withholding certificate would not be received until sometime in 2016. In this case, the seller may choose to have the $90,000 withheld and file the tax return in early 2017.
FEES TO THE PREPARER
Preparing the form 8288B application for withholding certificate is detailed and complicated, and should be performed by a tax preparer, CPA or attorney experienced with FIRPTA matters. Fees vary among preparers, but expect to pay from $1,000 to $3,500 based on the experience of the preparer. Applications succeed based on completeness and accuracy, as well as experience of the tax preparer. Rejections occur frequently due to errors and omissions made by those who are inexperienced, or attempting filings without the use of a professional.
Nace Cohen, CPA, CAA is a specialist in international income taxation and 1031 exchanges. He is also a Certified Acceptance Agent who can assist our foreign friends with making application for a U.S. Taxpayer Identification number. Based in Captiva, Florida, please call us toll free at (888) 659-1031, or Email Nace direct at Nace@1031connection.com. Visit our web site at www.1031Connection.com for more information.