Investing In Real Estate In The United States as an NRA? Know FIRPTA!
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A few weeks ago, I had frantic messages from a non-US person who wanted to know what she needed to do stop the Title Company from withholding taxes on the sale of her Florida property.
I knew she was talking about taxes being withheld under FIRPTA. If this is something you did not know or had only heard about, it will come as a huge surprise as a nonresident individual who is trying to sell a real property in the U.S and are not aware of these rules, that you may owe tax to the U.S government even if you are not making any money on the sale.
Generally, capital gains earned by nonresident individuals are not subject to U.S tax. In order to get around that, the FIRPTA taxes sale of the U.S. real estate by nonresident persons.
Hence it is important to understand FIRPTA rules especially if you are thinking of investing in the U.S real estate market as a nonresident or are soon to exit the U.S leaving behind rental real estate in the U.S, and will become an NRA once you leave.
Let us look at practical issues and steps to take to make sure the sale is clean and is reported to the IRS correctly and timely.
So here is a high level overview of FIRPTA. Please keep reading for practical issues to consider and maybe mitigate some of this tax burden.
But first, what is FIRPTA?
FIRPTA stands for Foreign Investment in Real Property Tax Act and was passed in 1980. The FIRPTA authorizes United States government to tax foreign persons on dispositions of U.S. real property.
By disposition, they mean sale/ redemption/ liquidation/ exchange/ gifts/ transfers and more.
The buyer of the property should find out if the seller is a foreign person, withhold tax @ 15% and remit it to the Internal Revenue Service. If a foreign corporation is disposing U.S property, the entity will withhold tax @ 21% before distributing to its foreign shareholders.
The 15% withholding is based on the selling price of the property/ amount realized. Hence, the withholding is on the sum of:
- The cash paid/ to be paid
- The fair market value (FMV) of other property transferred/ to be transferred, and
- The amount of any liability assumed by the transferee or to which the property is subject to immediately before and after the transfer.
Who will FIRPTA apply to?
The rules apply to a "foreign person". A foreign person is a nonresident alien individual or a foreign corporation that has not made an election to be treated as a domestic corporation or a foreign trust or foreign partnership or foreign estate. A foreign person is NOT a resident alien individual.
How is FIRPTA reported?
The following forms are used to report and pay tax that is required to be withheld on the dispositions:
- Form 8288: The tax withheld on the purchase of the U.S real property from a foreign person is reported to the IRS via this form. This form needs to be filed within 20 days from date of purchase. It is sent to the IRS along with copies A and B of Form 8288-A.
- Form 8288-A: The buyer/ transferee of the U.S property prepares this for each of the foreign person for whom tax is withheld on the sale, attaches copies A & B to Form 8288 and mails it to the IRS. Copy C is maintained in their records.
- Form 8288-B: This is the form the seller/ transferor uses to apply for a reduced rate of withholding from the IRS under Categories 1, 2 and 3. The link to these Categories are in the Bibliography below.
- Forms 8804 and 8805: Partnerships that have foreign partner/s and are disposing of U.S. real property, use these forms to report and pay withholding to the IRS.
- Form 1042-S: Publicly traded trusts and real estate investment trusts use this form to report and pay tax withheld on sale or distributions of U.S. real property interests.
- Form 1099-S: This is the form used by the real estate broker or person responsible for closing the transaction to report the sale to the IRS.
Practical Issues To Consider:
- Request reduction or elimination of withholding: File the Form 8288-B with the IRS with supporting calculations that show how much you may actually owe on the sale. Timing is important here, as you will have to file as soon as you go into contract but before the closing date.
- Accept withholding and file tax return after-the-fact: If you are not able to apply for the reduced withholding or are denied the application or do not have time to apply within the period available, you can wait for the filing season for the sale year to start, which is usually next January after the year of sale, and file a tax return showing actual gains made from the sale (if any) and apply the credit and receive a refund. Use Form 1040-NR to file a tax return.
- Make an early request for a refund of the FIRPTA withholding: Under very limited circumstances, you can make an early request for a refund of the FIRPTA taxes withheld if you are unable to reduce or eliminate the withholding and cannot wait to file your tax return.
Exceptions to FIRPTA Withholding:
Check to see if you are eligible for any of the many exceptions to FIRPTA withholding. Note that even if an exception may apply to you, you may still need to file the forms above to notify that a sale/ purchase has occurred in which a nonresident individual or foreign person is involved.
Always work with qualified individuals who are knowledgeable about all cross-border matters and have had experience in this field. These blog posts are to provide you with the ability to plan for and ask questions of tax professionals you hire so that you can gauge their ability to assist you.
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