The FIRPTA and PATH Act of 2015
Effective February 17, 2016, Buyers of U.S. real estate must withhold and remit 15% (previously 10%) of a property’s sales price to the IRS if the Seller is a “foreign” person pursuant to the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”), as recently amended by the PATH Act of 2015. The Buyer must remit the 15% FIRPTA withholding to the IRS within 20 days after the closing or else face penalties and liability for any tax owed by the foreign Seller to the IRS. The foreign Seller, in turn, must file an income tax return reporting all U.S. income, reflecting the 15% FIRPTA withholding as a prepayment of any income tax due, and pay any balance due or claim any allowable refund.
Put in simple terms: A foreign Seller receives only 85% of the sales price because the IRS requires automatic withholding of the remaining 15%. Although the foreign Seller can eventually obtain part (and sometimes all) of the 15% via an IRS refund, the Seller must wait several months before obtaining the refund. For example, if a property sells on February 20, 2016, the earliest that the foreign Seller can apply for a refund for the 15% FIRPTA withholding is in January of 2017.
As with any general rule, there are exceptions to the 15% FIRPTA withholding. Nevertheless, because these exceptions rarely apply and/or are inconvenient, a foreign Seller’s best chance at receiving 100% of the sales price is to take steps to not be considered a “foreign” Seller at all.
Individual Buyer Personal Residence Exception
This exception can either reduce the FIRPTA withholding to 10% (from 15%) or entirely eliminate it. To qualify, the Buyer must (a) be an individual and (b) intend to use the property as a residence. If both are true, then the Buyer need withhold only 10% if the sales price does not exceed $1.0 million, or, if the sales price does not exceed $300,000, the Buyer need not withhold anything at all (0%).
The problem with this exception is that it rarely applies. Buyers are often not an individual, but rather a corporate entity (e.g., LLC, corporations). Even when they are, an individual Buyer often does not intend to use the property as a “residence” within the technical meaning of the term under the Internal Revenue Code (for example, Buyer intends to rent the property or to use it as a vacation home). And sometimes, the Buyer simply does not want to risk violating the IRS’ “residency” requirement because it is the Buyer who is liable for improperly failing to withhold the required 15%. In other words, in applying this exception the “foreign” Seller receives the entire benefit (receives entire purchase price) while the Buyer receives no benefit (pays entire purchase price) and takes on unnecessary risk (liability with the IRS).
Withholding Certificate Exception
If the actual tax owed by the foreign Seller on the transaction will be less than the 15% withholding, the foreign Seller may apply for a withholding certificate issued by IRS. The application must be submitted to the IRS no later than the date of closing or the 15% will be sent to the IRS. Once submitted, the IRS normally takes 90 days to issue the withholding certificate. In most cases, the closing occurs before the withholding certificate is issued. In this case, the closing takes place and the 15% is withheld, but rather than remitting to the IRS, the Buyer is authorized to hold the funds in the closing agent’s escrow account until the foreign Seller receives the withholding certificate. Once the withholding certificate is received, the closing agent will remit the amount required by the withholding certificate, if any, and release the balance of the funds directly to the foreign Seller.
Avoiding “Foreign” Seller Status
There are a few ways in which a foreign Seller can avoid the automatic 15% withholding Some of the alternatives include holding title to the property under a corporate entity, such as an LLC or Corporation. Contact Barbosa Legal to discuss the best alternatives for your particular situation and avoid any withholding when selling your US property.