What is FIRPTA? A guide for foreign sellers and US buyers

Are you wondering "what is FIRPTA" and how it affects your real estate transaction? The Foreign Investment in Real Property Tax Act (FIRPTA) withholding represents a critical tax requirement that impacts all foreign persons selling US real estate.

This specific legislation was brought in back in 1980, to ensure proper tax collection from foreign sellers on their US property gains. As the US real estate market continues to attract international investors, understanding FIRPTA requirements has become essential for both buyers and sellers to ensure smooth, compliant transactions.

It’s always important to keep up to date as legislation can shift, especially with the new administration expected to shake up taxes, the economy, and foreign policy.

What is FIRPTA?

The Foreign Investment in Real Property Tax Act (FIRPTA) is a vital piece of US tax legislation that significantly impacts international real estate transactions. When Congress enacted FIRPTA, it established a comprehensive framework for taxing foreign persons on the disposition of their US real property interests (USRPI). This law has significantly shaped FIRPTA real estate transactions, creating a standardized process for tax collection from foreign sellers.

Why was FIRPTA enacted?

Before this law, many foreign investors avoided paying US taxes on their real estate profits by structuring sales through foreign corporations. Congress enacted FIRPTA to address three critical concerns:

• growing foreign investment in US real estate markets
• difficulty tracking property sales by foreign persons
• need for an efficient tax collection mechanism

FIRPTA aims to level the playing field for domestic and foreign investors, ensuring that everyone pays their fair share of taxes.

NOTE! The law applies to all foreign sellers, regardless of the transaction size.

What qualifies as a US Real Property Interest (USRPI)?

A US Real Property Interest (USRPI) encompasses more than just physical real estate. It includes direct ownership of residential or commercial property, mineral rights, natural resource deposits, interests in US real property holding corporations, certain personal property associated with real property use, and various leasehold interests in US real property.

Understanding the full scope of USRPIs is key for foreign investors wishing to remain in complete compliance with FIRPTA regulations.

 

FIRPTA filing and reporting responsibilities

FIRPTA requirements for documentation on foreign property sales consist of four critical forms that together will ensure proper tax withholding and reporting for non-US property sellers.

• Form 8288 serves as the primary reporting document for buyers, capturing the total tax withheld from foreign property transactions. Buyers must submit this form to the Internal Revenue Service (IRS) within 20 days of the property transfer.
• Form 8288-A accompanies this document, providing detailed transaction information and withholding statements.
• Form W-7 is for foreign sellers without a US Social Security Number, it is used to obtain an Individual Taxpayer Identification Number (ITIN).
• Form 1040-NR functions as the non-resident tax return, ultimately reconciling the withheld amount with the final tax liability.

FIRPTA penalties

Non-compliance with FIRPTA can lead to severe consequences for buyers, sellers, and real estate professionals. Late filing penalties can reach up to 25% of the required withholding amount, with additional interest charges accruing on late payments.

Buyers may face personal liability for the full tax amount if required withholding isn't performed, potentially resulting in tens of thousands of dollars in unexpected costs.

Make sure you understand all FIRPTA obligations or you’ve hired a professional that does before engaging in real estate transactions involving foreign sellers. The IRS takes FIRPTA violations very seriously, with penalties including:

• up to $10,000 fines for willfully providing incorrect information on Forms 8288
• potential property confiscation in extreme cases
• civil and criminal penalties for non-compliance
• additional fines equal to the withholding amount for responsible parties

How the FIRPTA withholding tax works

FIRPTA real estate transactions require buyers to set aside a portion of the sale price when purchasing US property from foreign sellers (FIRPTA withholding tax rate is 15%).

Think of the FIRPTA withholding rate as a security deposit that the IRS requires when a foreign person sells US real estate, to ensure it receives the taxes owed on the sale. The buyer acts as the middleman, collecting and remitting this "deposit" on behalf of the seller.

NOTE! While the withholding rate is generally 15%, there are some exceptions shown below.

Who is subject to FIRPTA withholding?

The definition of a FIRPTA foreign person extends beyond non-US citizens. It includes non-resident alien individuals, foreign corporations, foreign partnerships, foreign trusts and estates, and any other entity not considered a US person for tax purposes.
You are subject to FIRPTA withholding if you are:

• a non-resident alien individual
• a foreign corporation
• a foreign partnership
• a foreign trust or estate
• any other entity not recognized as a US person for tax purposes

Let's imagine a diverse group gathered in a room –  you might see a Canadian retiree who owns a Florida vacation home, a Singapore-based corporation investing in US commercial property, and a UK family trust holding US residential real estate. All of these entities would be subject to FIRPTA withholding when selling their US property, regardless of other US ties they may have.

Worth mentioning here is that one's immigration or residency status doesn't always align with their FIRPTA status.
 

Buyer's responsibility as withholding agent

When you purchase property from a foreign seller, you become a withholding agent. Your duties include verifying the seller's status through proper documentation and calculating the correct withholding amount. You must complete and submit the FIRPTA withholding form (Form 8288) to the IRS and remit the withheld amount within 20 days of the transfer.

The process for a foreign seller

As a foreign seller, you must follow several essential steps to ensure compliance:

1. Obtain a US Individual Taxpayer Identification Number (ITIN).
2. Prepare and file required tax returns.
3. Report the sale on your US tax return.
4. Request any applicable refunds of excess withholding.
5. Maintain documentation of the transaction and tax payments.

Pro tip: Remember, the amount withheld is not necessarily your final tax liability. It's essentially a prepayment of the potential taxes you may owe. When you file your US tax return, you'll calculate your actual tax liability based on your overall situation. If the amount withheld exceeds what you owe, you can request a refund of the excess.

Exceptions to FIRPTA withholding

Several important FIRPTA withholding exceptions might apply to your transaction:

1. Buyer's residence exemption: If the property is acquired by the buyer for use as a residence and the purchase price is less than $300,000, FIRPTA withholding may not be required.
2. Non-foreign affidavit: If the seller provides a signed affidavit to the buyer stating that the seller is not a foreign person, withholding may not be necessary.
3. Withholding certificate: The seller may apply for a withholding certificate from the IRS to reduce or eliminate withholding if they believe their tax liability will be less than the amount required to be withheld.
4. Treaty benefits: Certain income tax treaty provisions may provide exemptions or reduced rates for FIRPTA withholding, depending on the seller's country of residence.
5. Corporate reorganizations: Some corporate reorganizations, such as certain transfers of property between related companies, may be exempt from FIRPTA withholding if they meet specific IRS requirements.

What is a FIRPTA withholding certificate?

A FIRPTA withholding certificate (Form 8288-B) can be a valuable tool for foreign sellers of US real estate. It allows you to request a reduction or elimination of the standard 15% withholding amount when your expected tax liability is lower than the withheld sum.

Think of it like this: if you're expecting a $1,000 tax bill but the buyer withholds $1,500, that's an extra $500 the IRS holds until you file a return and request a refund. With a withholding certificate, you're saying, "I only owe $1,000, so let's adjust the withholding to match that." This can be advantageous in situations like:

• high-cost basis resulting in lower gain
• eligibility for treaty benefits
• deferred tax under nonrecognition rules

The key here is to file Form 8288-B early, ideally by the transfer date, to give the IRS time to review and approve the adjustment.

How do I apply for a withholding certificate?

This is the process you should follow, along with some key resources:

1. Complete the IRS Form 8288-B, with accurate transaction details. Be sure to check the instructions for the form.
2. Gather all your supporting documentation and submit this with the form on or before the transfer date.
3. Allow approximately 90 for the IRS to review this info. Make sure you keep any contact info you’re provided when submitting, for any follow-ups.

Mistakes can lead to significant tax implications, so consider having an expert review your submission or help you with the process.

Conclusion

Understanding and complying with FIRPTA is crucial for successful US property transactions involving foreign sellers. This complex legislation affects the whole chain: buyers, sellers, and real estate professionals. There are significant financial implications for non-compliance, so reaching out for guidance with complex regulations is always best to ensure smooth transactions and avoid costly penalties.

Key takeaways:

• Buyers must withhold 15% of the sale price in most cases.
• Exceptions exist for certain residential purchases and situations with proper certifications.
• Accurate and timely filing of Forms 8288 and 8288-A is essential.
• Foreign sellers should consider applying for withholding certificates when appropriate.

FIRPTA is not just a legal obligation, it's a critical component of responsible international real estate investment. As the US real estate market continues to attract international investors, you should stay informed of our latest posts covering a range of expat tax topics, specifically areas such as FIRPTA requirements, deadlines, and potential exceptions.