The United States of America offers many incentives to foreign investors who invest in real estate in the country: no specific visa is required and the tax deductions are generous! However, at the time of sale, a foreign investor might be surprised by the complex reporting obligations and the potentially high withholding tax on the selling price (FIRPTA). Below the FIRPTA mechanism explained and how to make the selling process as smooth as possible!
What is FIRPTA?
Under the Foreign Investment in Real Estate Tax Act, any foreign individual or foreign entity is subject to US income tax on the sale of US real estate. FIRPTA aims at minimizing the risk that the US tax administration (IRS) will not collect tax from foreign parties. The FIRPTA withholding functions as a “prepayment” of tax - that ensures that the IRS will collect any tax due in the event the foreign national does not report his sale voluntarily to the authorities.
Which individuals are subject to FIRPTA?
Any foreign individual who sells real estate in the US is subject to FIRPTA - included individuals are:
1. An individual who does not hold U.S. citizenship
2. An individual who does not hold permanent residence ( green card )
3. An individual whose presence in the United States does not meet the number of days of the Substantial presence test.
4. Any sale of commercial real estate
Read more on Substantial Presence Test. https://www.kbfinancials.biz/us-tax-residency--the-183-day-rule.html
Which companies are subject to FIRPTA?
Single Member LLC
An LLC with a single foreign member is a disregarded entity: its activity is taxable at the level of its member. In this situation, the LLC is subject to the FIRPTA on sale of real estate.
Multiple member LLC
An LLC with several foreign members is by default a Partnership: the profit of the LLC is subject to withholding tax §1446 ( Effectively Connected Income ) of 21% (if the partners are a foreign corporation) and 37% (if the partners are foreign individuals). An LLC that has paid the §1446 withholding tax is not subject to FIRPTA withholding.
A US corporation is subject to FIRPTA withholding if at least 50% of its assets are real estate (USRPI - US Real Property Interest ). A foreign corporation is subject to FIRPTA.
What is the FIRPTA withholding rate?
The FIRPTA withholding rate is 15% for sales made by individuals and 21% for sales made by corporations.
Learn more: https://www.irs.gov/individuals/international-taxpayers/firpta-withholding
Who is responsible for withholding the tax?
The buyer of a U.S. real property is responsible for withholding FIRPTA from the amount realized (usually the sales price). The tax must be remitted to the IRS within 20 days of date of the sale. The buyer will be subject to penalties if he fails to withhold properly.
How does the seller recover the FIRPTA withholding?
The year of the sale, the buyer collects, reports and remits the FIRPTA withholding to the IRS ( Forms 8288, 8288-A).
The year after the sale, the seller files a US tax return (Form 1040NR) which calculates the tax actually due on the realized capital gain . Any over-payment of tax is refunded to him.
To find out more about the taxation of capital gains - https://www.kbfinancials.biz/l-imp-t-sur-les-plus-values--capital-gain-tax--.html
Note - Applying for an ITIN - Recovering the FIRPTA withholding will require the seller to obtain an individual tax Identification Number (ITIN). - To find out more about the ITIN process: https://www.kbfinancials.biz/itin-services.html
Are there exceptions to FIRPTA?
There are many exceptions that exempt the foreign seller from FIRPTA. The 2 most common exceptions are:
Future use of the property by the buyer
If the buyer will use the property as his primary residence and the sale price is less than $300K, the transaction is not subject to FIRPTA. To qualify for the exemption of tax, the buyer must certify that during the 2 years following the date of purchase, he plans to reside more than 50% of his time in the property. If the sale price is greater than $ 300K but less than $ 1 million, the FIRPTA withholding is reduced to 10%.
To learn more about FIRPTA exceptions: https://www.irs.gov/individuals/international-taxpayers/exceptions-from-firpta-withholding
Sale through an exchange 1031
In a “1031 exchange” (or “like kind exchange”), the taxation of the capital gain is deferred. As a result, the transaction is exempt from FIRPTA.
To find out more about 1031 exchanges: https://www.kbfinancials.biz/comment--viter-l-imposition-imm-diate-de-la-plus-value---le-transfert-1031.html
As soon as you are considering selling or purchasing a real property, you need to start planning for FIRPTA. Contact Karine Bauer EA at Kbauer Financials LLC to determine your potential tax liability and to assist you with preparing the FIRPTA forms to submit the day of the closing. As always, the views contained in this article are not tax or legal advice and are not a substitute for consulting with a tax professional. Karine Bauer, EA is an Enrolled Agent licensed by the Treasury Department with unlimited rights to represent taxpayers before the Internal Revenue Service. She is an experienced tax professional with more than 20 years of international experience.
Bear in mind the date of this article as tax laws change overtime.
Updated February 21st, 2021