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A Primer on FIRPTA Withholding

At its most basic, any disposition of a U.S. real property interest by a foreign person (as transferor) is subject to the Foreign Investment in Real Property Act of 1980, more commonly known as FIRPTA.[1] So, when a foreign person or entity sells, transfers, or otherwise disposes of a piece of U.S. real property, the transferee will likely have to withhold a certain percentage of the sales price.[2]

Defining Disposition

The term disposition as used in FIRPTA is not limited to the sale of property.  A FIRPTA disposition is any exchange, liquidation, gift, transfer, redemption, etc. of real property or an interest in such property.[3]  The term is very broadly defined,[4] and so when in doubt, it is best to treat a transaction or transfer with a foreign transferor and with respect to real property as a FIRPTA disposition.

Defining U.S. Real Property Interest

A U.S. real property interest under FIRPTA is an interest (other than an interest held as a creditor) in real property located in the United States (including the Virgin Islands) and includes certain personal property that is associated with the use of real property (such as farming machinery).[5]  Such interests include homes, buildings, apartments, and other commonly accepted real property interests, but it also includes interests in mines, wells, or other natural deposits.[6]

Corporate Interests as Real Property Interests – Default Position

Interestingly, FIRPTA also defines U.S. real property interests as any interest (again, other than as a creditor) in any domestic corporation unless it is established that the corporation was at no time a U.S. real property holding corporation.[7]  Thus, the IRS has a default presumption that the corporation owned by a foreign individual was a U.S. real property holding corporation, and this presumption must be overcome by the taxpayer.[8]

When is an Interest in a Corporation not a U.S. Real Property Interest?

The easiest and most obvious answer is that a corporation which did not hold any U.S. real property interests at the date of disposition is not a corporation that needs to worry about FIRPTA.  If, however, the corporation did at one time hold U.S. real property interests during the applicable period (generally 5 years before the date of disposition), the corporation will be treated as holding an interest in U.S. real property at the time of the transaction, unless the interests were disposed of in transactions in which the full amount of any gain was recognized.  After 2016, so long as the corporation (or its predecessor) wasn’t a regulated investment company (RIC) or real estate investment trust (REIT), then the corporation will likely not fall under FIRPTA’s regulations.

Withholding and Rate of Withholding

The transferee must deduct and withhold a tax on the total amount realized by the foreign person on the disposition.[9]  The rate of withholding generally is 15% (10% for dispositions before February 17, 2016).[10] The PATH Act of 2015 amended Section 324 of FIRPTA by increasing the rate of withholding from 10% to 15%.[11] However, the withholding rate of 10% still applies to the sale of property where the amount realized is $1 million or less AND the purchaser of the property signs an affidavit that the house will be used as their primary residence.

The amount realized is the sum of the cash paid, or to be paid (principal only); the fair market value of other property transferred, or to be transferred; and the amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.[12]

A domestic corporation must withhold tax on the fair market value of the property distributed to a foreign shareholder if (a) the shareholder’s interest in the corporation is a U.S. real property interest; and (b) the property distributed is either in redemption of stock or in liquidation of the corporation.[13]

Exceptions to FIRPTA Withholding

There are eleven discrete exceptions to FIRPTA withholding,[14] though you are only likely to run across a few of these: (a) the residency test; (b) certifications; and (c) withholding certificates.

The Residency Test

If the transferee is an individual who acquires the property for use as a residence and (a) the sales price is not more than $300,000, and (b) the transferee or a member of the transferee’s family has definite plans to reside at the property for at least 50% of the first two years following the date of transfer, then the transferee meets the residency test, and no FIRPTA withholding is necessary.[15] For this test, the transferee must be an individual.

The Affidavit / Certification

If the transferor gives the transferee, the closing attorney, or title company a certification in the form of an affidavit stating, under penalties of perjury, that the transferor is not a foreign person and containing the transferor’s name, U.S. taxpayer identification number, and home address (or office address, in the case of an entity), then the transferor is exempted from FIRPTA withholding.[16]  These certifications are not effective if the transferor has actual knowledge or receives notice that they are false.[17]  Further, if the transferor fails to furnish a copy of the certificate to the IRS upon request, the certificate is not effective.[18] The transferor may also receive a withholding certificate from the IRS, which also excuses withholding.[19]

Liability of Agent

A “withholding agent” is personally liable for the full amount of FIRPTA withholding tax required to be withheld, plus penalties and interest.[20]  A withholding agent, such as a closing attorney or title company, is any person having the control, receipt, custody, disposal or payment of income that is subject to withholding.  Generally, the person who pays an amount to the foreign person subject to withholding must engage in FIRPTA withholding.

Applying for a Withholding Certificate

The seller (transferor) must have a TIN to transfer the property.[21] In a perfect world, the transferor should, in advance of closing, file an IRS Form 8288-B Application for Withholding Certificate to request a reduced amount or no withholding.[22]  The IRS has 90 days to issue the withholding certificate from the receipt of the application.[23]

Special Rules Concerning Distributions and Other Transactions by Corporations, Partnerships, Trusts, And Estates

The Code and Treasury Regulations contain complex rules regarding rules and exceptions in transactions involving domestic and foreign corporations, partnerships, trusts, and estates.[24] These rules are outside the purview of this brief summary.


Footnotes:

[1] Codified at IRC § 897.  For a very detailed analysis of FIRPTA, see Internal Revenue Manual § 4.61.12.

[2] See generally IRC § 1445.

[3] IRC § 904(f)(3); Treas. Reg. § 1.897-1(g).

[4] See Treas. Reg. § 1.897-1(g) (noting that the term “disposition” means any transfer that would constitute a disposition by the transferor for any purpose under the IRC or Treasury Regulations).

[5] Treas. Reg. § 1.897-1(b) (real property, generally); Treas. Reg. § 1.897-1(b)(4) (personal property associated with the use of real property, specifically)

[6] Id.

[7] Treas. Reg. § 1.897-1(c)(1)(ii).

[8] Treas. Reg. § 1.1445-4(c).

[9] See IRC § 1445(a); Treas. Reg. § 1.1445-1.

[10] A foreign corporation that distributes a U.S. real property interest must withhold a tax equal to 21% of the gain it recognizes on the distribution to its shareholders.

[11] Click here for a PDF of the PATH Act.

[12] Treas. Reg. § 1.1445-1(g)(5)(i)-(iii).

[13] For distributions before February 17, 2016, the corporation generally must withhold 10% of the amount realized by a foreign person. For distributions after February 16, 2016, the rate increases to 15%.

[14] See Treas. Reg. § 1445-2. For a complete (and greatly simplified list of FIRPTA withholding exceptions, click here).

[15] When counting the number of days that the property is used, the transferee does not count the days the property will be vacant.

[16] See IRC § 1445(b); Treas. Reg. § 1.1445-2(b)(2).

[17] IRC § 1445(b)(7)(A).

[18] IRC § 1445(d)(2)(A).

[19] IRC § 1445(b)(4)(B).

[20] IRC § 1445(d)(2)(A); Treas. Reg. § 1.1445-4(c)(1).

[21] IRC § 1445(b)(2).

[22] IRC § 1445(c)(3); Treas. Reg. § 1.1445-3(c)(3)(ii)(B).

[23] IRC § 1445(c)(3); Treas. Reg. § 1.1445-3(a).

[24] IRC § 1445(e); Treas. Reg. § 1.1445-5(a).

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