WHAT IS FIRPTA?
United States tax law requires that all persons, whether foreign or domestic, pay income tax on the disposition of U.S. real property interests. Domestic persons or entities typically are subject to this tax as part of their regular income tax; however, the U.S. needed a way to collect taxes from foreign persons on the sale of U.S. real property interests. The Foreign Investor in Real Property Act (“FIRPTA”) was enacted to provide such a mechanism and requires that a buyer withhold and remit to the IRS a certain percentage of the sales price in anticipation of the taxes that will be due from the foreign seller on such transaction. FIRPTA applies in nearly all transactions, residential and commercial, in which a foreign owner of a U.S. real property interest sells such interest. The amount withheld is not the tax itself, but is payment on account, of the taxes that ultimately will be due from the seller.
WHAT ARE THE WITHHOLDING REQUIREMENTS?
Unless an exemption or reduced rate applies, FIRPTA requires that the buyer withhold fifteen percent (15%) of the sales price in all transactions in which the seller of a U.S. real property interest is a “Foreign Person.”
WHO IS A “FOREIGN PERSON”?
FIRPTA defines a “Foreign Person” by defining who is not a Foreign Person, so it is important to understand the following definitions:
- A “Foreign Person” is defined as any person other than a “United States Person.”
- A “United States Person” is any of the following: (i) a U.S. Citizen; (ii) a resident alien who has a Green Card; (iii) a resident alien who meets the Substantial Presence Test; (iv) a domestic (U.S.) corporation, partnership or other legal entity (except a “Disregarded Entity” as defined by IRS Regulations), trustee or other fiduciary; (v) a Disregarded Entity, the owner of which qualifies as a “United States Person” under (i), (ii), (iii), or (iv), above; or (vi) a foreign entity which has elected to be treated as a domestic corporation (as evidenced by acknowledgement copy of election furnished by IRS).
- The Substantial Presence Test: Under FIRPTA, a Foreign Person is considered a U.S. Person for the calendar year of sale if they are present in the United States for at least:
- 31 days during year of sale AND
- 183 days during the 3 year period that includes year of sale and the 2 years preceding year of sale, but only counting:
- All days during year of sale;
- 1/3rd of the days during the first preceding year; and
- 1/6th of days during the second preceding year.
When counting days, you may not include the days that a Foreign Person is present in the U.S. as a representative of a foreign government (e.g. foreign diplomat), as a teacher or student under a “J”, “Q”, “F” or “M” Visa, or as a professional athlete in a charitable sports event.
- A “Disregarded Entity” is any single-owner domestic business entity (such as a single-member limited liability company) other than a corporation, unless it has elected to be treated as a domestic association for tax purposes.
WHAT IF THE SELLER IS A DOMESTIC LLC?
Single-Member LLC:
A single-member domestic limited liability company, while a recognized legal entity, is considered a “Disregarded Entity” for tax purposes. Accordingly, if the seller is a single-member limited liability company, then you have to look to the identity of the sole member of the limited liability company. If the sole member is a “Foreign Person,” then the FIRPTA withholding rules apply in the same manner as if the foreign sole member was the seller.
Multi-Member LLC:
A domestic limited liability company with more than one owner is not considered a “Disregarded Entity” and is taxed differently than single-member limited liability companies. Accordingly, the FIRPTA rules regarding withholding do not apply to multi-member domestic limited liability companies.
WHO IS RESPONSIBLE FOR COMPLYING WITH FIRPTA?
While the seller is the party subjected to the tax, it is up to the buyer to withhold the appropriate percentage of the sales price when purchasing U.S. real property from a “Foreign Person.” In the event the buyer does not properly withhold, the buyer may be liable to the IRS in an amount equal to the amount of taxes that should have been withheld, plus interest and penalties.
While the buyer has the ultimate liability to the IRS, the collection and disbursement of funds to the IRS as part of the closing process creates a responsibility and potential liability for the settlement agent if the matter is not properly handled and documented. Accordingly, it is important that your file reflect specific written direction from the buyer if anything other than fifteen 15% is being withheld. For example, if a buyer elects to waive the withholding or withhold a reduced rate, settlement agents should obtain an affidavit from the buyer setting forth the buyer’s decision and, if applicable, the facts that entitle the buyer to the exemption or reduced rate along with an acknowledgement that the buyer has been given the opportunity to obtain independent tax or legal advice.
HOW IS THE WITHHOLDING SUBMITTED AND REPORTED?
Generally, the funds withheld must be forwarded, together with IRS Forms 8288 and 8288-A, to the IRS within 20 days after the closing date. However, if an application for a withholding certificate is submitted to the IRS before the date of a sale and the application is still pending with the IRS on the closing date, 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.
ARE ITIN’s REQUIRED FOR ALL PARTIES?
IRS regulations require all buyers and foreign sellers of U.S. real property interests to provide their TINs, names, and addresses on withholding tax returns, applications for withholding certificates, notice of non-recognition, and other related IRS documents when disposing of a U.S. real property interest. While it is best practice to have the TINs for all parties at the time of closing, it is possible to close without the TINs under the following guidelines:
- If the buyer does not have a ITIN, the buyer must remit the proper withholding forms within 20 days after closing; however, the buyer will also need to remit, to a separate address in a separate package, a properly completed application (Form W-7) for a ITIN simultaneously with remitting the withholding forms. Please refer to the instructions for each form for further instructions and mailing addresses.
- If the seller does not have a TIN, the buyer must remit the proper withholding forms within 20 days after closing, but the seller’s TIN information will be left blank. While the TIN is not necessary for closing, it should be noted that the seller will have to obtain a TIN in order for the IRS to process the funds and, in fact, upon receipt of the withholding documentation, the IRS will follow up with the seller instructing the seller to apply for a TIN. For this reason, many settlement agents provide the friendly advice that the seller submit its separate application for a TIN by the time of closing.
Additional information can be found in the IRS publication entitled “ITIN Guidance for Foreign Property Buyers/Sellers,” which is available at www.irs.gov.