FIRPTA Withholding – All You Need To Know
FIRPTA withholding can be tricky, especially if you've never heard of it. You may not be aware of how it works, who is exempt, and how to avoid it. In this article, you'll find the basics of FIRPTA withholding and answer some of the most common questions. Read on to discover more about this tax law and the best way to avoid it.
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You may have wondered: what is FIRPTA withholding? You’ve probably heard the acronym, but what exactly is it, and why is it important to your business? FIRPTA is the acronym for the Foreign Investment in Real Property Tax Act, which was enacted in 1980 and requires that any sale of a foreign real estate property result in income tax withholding. This tax is imposed on capital gains and must be paid to the IRS within 20 days of the sale.
Under FIRPTA, 15 percent of the sale price must be withheld to provide an equal playing field for foreign nationals. U.S. agents must verify the foreign national status of the seller to ensure proper withholding. If the withholding is lower than the tax owed, the IRS will refund the difference in tax. This can be a significant burden, so you should plan ahead and obtain certified copies of all your documents.
How to avoid FIRPTA withholding?
If the seller is a U.S. citizen, you don’t have to worry about FIRPTA withholding because it only applies to people from outside the U.S. But the IRS may see some green card holders as being from another country. Also, some foreigners may have Social Security numbers that are still good.
There is also no FIRPTA withholding if the sale price is less than $300,000 and the buyer plans to use the property mostly as a home. To qualify for this exception, the buyer must sign a statement that they plan to live in the property for more than half of the days it is used by anyone in the first 24 months after the sale.
A withholding certificate is the only other way to get around FIRPTA. If the amount withheld by FIRPTA is more than the maximum amount of tax due on the sale of the property, the seller can ask the IRS to lower the amount withheld. For example, FIRPTA doesn’t have to be used if the non-resident person loses money when the property is sold.
IRS Form 8288-B is usually used to apply for a withholding certificate because it is a complicated process (Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests).
Form 8288-B needs to be submitted with several attachments and certifications. The certificate also needs to be filed before or on the closing date, so it’s important to start gathering the necessary information well before the deal is supposed to close. The IRS has 120 days to let a lower amount to be taken out. The money taken out for FIRPTA should be held in escrow until the IRS makes a decision.
Who is exempt from FIRPTA withholding?
FIRPTA withholding applies to a portion of the sale price paid to a foreign seller. A foreign seller must meet certain identifying requirements to avoid having a portion of the sale price withheld from the buyer. They must obtain a U.S. Tax ID number and fill out a W-7 application. The seller must also pay tax on a percentage of their sales to the IRS within 20 days of closing. Fortunately, there are ways to avoid this tax law.
There are many exceptions to this tax law, but most cases involve transactions between U.S. citizens and foreign non-residents. Generally, non-resident aliens who own real estate in the U.S. must file a U.S. tax return for the year the property is sold and pay the appropriate tax at the time of sale. Any tax not remitted in time will incur penalties and interest.
Case Studies: Examples of FIRPTA Withholding
Case Study 1: An individual from Country A sells a U.S. property for $500,000. The buyer is required to withhold 15% of the sales price, amounting to $75,000, and remit it to the IRS.
Case Study 2: A foreign corporation sells its interest in a U.S. partnership that owns real property. The buyer must withhold 10% of the amount realized from the sale and submit it to the IRS.
Implications of FIRPTA Withholding
- Cash Flow Impact FIRPTA withholding can significantly impact the cash flow of foreign sellers, as a portion of their proceeds is held by the buyer until the withholding is remitted to the IRS.
- Tax Reporting Foreign sellers are required to file a U.S. tax return to report the sale and pay any additional tax liability that may arise from the transaction.
- Double Taxation In some cases, foreign investors may be subject to double taxation on the same gain due to their home country’s tax laws and U.S. tax laws. Tax treaties between the U.S. and certain countries may help mitigate this issue.
