Real Estate: FIRPTA
Our law firm specializes in international law and, as such, caters to foreign investors. For investors that come to us early, we are able to structure their US holdings in a way that avoids unnecessary complications, such as the Foreign Investment in Real Property Tax Act (FIRPTA). For those who come to us after the fact, we offer the following analysis.
I. Overview of FIRPTA
Simply put, FIRPTA is legislation intended to insure foreign owners of US real property pay the capital gains tax when they sell their property. After all, there is a natural temptation for someone living abroad to simply sell the property and disappear without paying tax.
The IRS knows this, so they have put the obligation on the buyer and the title agent to withhold 15% of the sale price as a sort of escrow for payment of capital gains tax.
Since it can be hard to go after the foreign seller, the law is aimed at the parties the IRS knows it can find and punish.
For the most part, the 15% is calculated on the sale price, not just the profit realized by the foreign seller. So, usually, the withholding is a substantial amount. That is the reason clients come to us for help.
II. The Typical Scenario
Sometimes the foreign investor does not know about FIRPTA when making the purchase. So, instead of creating a domestic land trust or LLC to purchase the property, the buyer just makes the purchase in his or her own name. Given the choice, that approach is probably not the best. Check here for other options. Florida Land Trust.
However, there are other times when purchasing through a land trust or company is not an option. For example, some lenders may require the borrower be a natural person. It is not impossible to get a mortgage in the name of a company or trust, but it can be more difficult. In that case, even if the foreign buyer knows about FIRPTA ,it may not be possible to avoid the issue. That said, since foreign buyers usually do not rely on US financing for their purchases, this is not generally an issue.
When it is time to sell the property, the client comes to us with these questions:
(i) Can I avoid the withholding requirement altogether?
(ii) If I can’t avoid withholding, can I minimize the amount withheld?
(iii) If I can’t avoid withholding, and the amount is fixed, can I at least get a quick refund?
Of course, each situation is a bit different, so there is not really a one-size-fits-all analysis. If you are in this situation, you really should contact our office for a free consultation. Just the same, there are some common factors we can cover here.
III. Withholding Requirement
First of all, how do you calculate the 15%? The IRS uses the term “amount realized” from the sale, which is defined as:
- The cash paid (usually the purchase price);
- The fair market value of other property transferred; and
- The amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.
If the property is owned jointly by U.S. and foreign persons, the “amount realized” is allocated between the seller parties based on the capital contribution of each. So, for example, if there is one US investor and one foreign investor, and they each put in 50% of the price to acquire the property, then the “amount realized” on the sale of the property will be half the sale price.
If the seller is a foreign corporation, then the company must withhold 35% of the gain it recognizes on the distribution to its shareholders. So, using a foreign corporation as the investment vehicle is usually not the best idea.
As for a domestic corporation, the company must withhold tax on the fair market value of the property distributed to a foreign shareholder if:
- The shareholder’s interest in the corporation is a U.S. real property interest, and
- The property distributed is either in redemption of stock or in liquidation of the corporation.
For a title agent, dealing with foreign sellers represents tremendous liability. In fact, our office often receives referrals from title companies that are less familiar with international transactions.
Typically, title agents who are unaccustomed to dealing with FIRPTA will get freaked out and end up making the process more slow and painful than it needs to be.
Probably the most common exception is where the buyer intends to live in the property as a home, as opposed to acquiring the property for rental/investment purposes. That can be helpful, but the sale price cannot be more than $300,000.
I know what you are thinking. If the buyer wants to live in the property but the sale price is greater than $300,000, you might be able to structure the sale in some creative fashion. Well, maybe, but there are at least two obstacles.
(1) If you have an existing mortgage, that will probably have to be paid off as part of the closing.
(2) Unless the buyer is paying cash, there will be little room for creative structures because the buyer’s lender will disallow whatever ideas you might come up with.
I am not saying it is impossible to satisfy the exception even though the property is worth more than $300,00, but it is tricky.
This is where your experienced, resourceful lawyer can really be helpful. There are certain mechanisms available for obtaining waiver of the withholding requirement. There are three in particular that provide some wiggle-room.
- The amount to be withheld is greater than the tax liability. The 10% is calculated on the full sale price even though you may have a mortgage to pay off. You only have to pay tax on your profit, not the full sale price. So, it could very well be the case that your tax liability is lower than the amount of the withholding. We would have to do the calculation based on your tax bracket to know for sure.
- Agreement to pay tax with conforming security. Since the whole idea of FIRPTA is to make sure you pay the capital gains tax, the IRS will consider waiving the withholding requirement as long as it has other assurances the tax will be paid. These are the forms of security that are generally acceptable:
– bond with surety or guarantor
– bond with collateral (the Ibis property would probably work)
– letter of credit (if you have funds abroad, this may be an option)
Under this scenario, we (the title company) would first determine the exact amount of tax due on the transaction, and then make arrangements to provide assurances the tax will be paid before April 15. If we can do that to the satisfaction of the agent, the IRS will issue a certificate that would allow the title company to refrain from withholding.
- Nonstandard application. This analysis really has to be done case-by-case, though I can give you an example. One client wanted to sell his property in order to raise enough money to meet the requirment for an investor visa (E-2). In that case, the argument was really quite compelling. After all, the IRS just wants to know the seller will not disappear without paying tax. Well, if the very reason for the sale is to be able to remain in the US on a long-term basis, that is pretty good assurance the seller will pay his taxes.
Bear in mind it does take a little time to get the certificate back so, if you decide waiver is the way to go, you will want to get the application together sooner rather than later.
VI. Amount of Withholding
As stated above, the sale price is typically used for purposes of calculating the 15% withholding. There are mechanisms for adjusting the amount of the withholding, but they are really the same as those discussed in § V above.
Besides that, the US does have tax treaties with some countries that reduce the amount of tax due. We would have to look at the specific treaty (if there is one) with your country to see if a reduction applies.
VII. Refund of Withholding
In general, you would apply for refund after filing your return and paying any tax due. So, how quickly you get your money back–assuming you are entitled to a refund–kind of depends up on you . . . to a point.
You do not have to wait until April of the following year, but you do probably have to wait until the end of the fiscal year in order to be able to file a complete return. Some exceptions may apply, depending upon your circumstances, but that is the general framework.
Also, there are some mechanisms for early refund but that, again, would really only apply if the withholding were greater than it should have been. The criteria and process would be the same as in § V above.
If you do file for an early refund, the Commission has 90 days to respond.
Obviously, as usual, the moral of the story is to seek out a lawyer sooner rather than later. Certainly, in some cases, FIRPTA will have to be dealt with. But, if you are a foreign investor, it would certainly be worth your while to meet with an HLA attorney to go over options regarding structuring your investment vehicle.