Updated: Jul 14, 2020
What is FIRPTA?
FIRPTA stands for the Foreign Investment in Real Property Tax Act. It is a federal tax law enacted in 1980 to apply a withholding tax to a foreign transferor of real property.
What is the Purpose of FIRPTA?
FIRPTA is a withholding tax on the transfer of real property from a foreign transferor to a buyer. Without the application of a withholding tax, the US would likely not collect income tax in the sale of real property.
The US taxes foreign owners of real property under one of two different tax methods. One option is to tax a foreign taxpayer‘s US real estate business like a US taxpayer’s real estate business, including deductions for depreciation, real estate taxes, etc and taxed at increased tax rates as net income increased.
The second method is to tax the rents from the real property at a flat rate. Usually the first method results in lower taxes.
When Does FIRPTA Apply?
FIRPTA applies to transfer of real property by foreign persons. A foreign person could be an individual, but also includes a corporation, partnership, trust, or foreign entity. A transfer generally means a sale, but also includes business transactions including a reorganization, liquidation, redemption of stock that impacts real property, a gift of real property, and other transactions where the beneficial ownership changes. The FIRPTA statute is designed to prevent creative planning around the application of the FIRPTA rules.
FIRPTA applies to a real property interest. This interest is described as an ownership interest, other than as a creditor, of property located in the United States of the US Virgin Islands, and may include personal property associated with the use of the real property.
Importantly, some foreign owners may use a US or domestic corporation (incorporated in one of the states of the US) to avoid a direct transfer from a foreign person. This type of transfer, when the real property is the primary holding of the domestic corporation, will generally run afoul of the FIRPTA rules.
What is the FIRPTA Tax Rate?
The FIRPTA tax withholding rate is currently 15% on the amount realized on the transfer. This is an increase of 10% that applied before February 17, 2016. Sellers must be aware of the impact FIRTPA has on the sale proceeds in the event the sales proceeds are needed to immediately fund another transaction or business expenditure.
If the transferor is a foreign corporation that distributes a US real property interest to its shareholders, the withholding rate is 21% of the gain it recognizes on the distribution to its shareholders. This is likely to be different from the amount realized.
How Does FIRPTA Affect the Buyer?
Real estate buyers must be aware of the risk that FIRPTA creates if the buyer does not properly comply with FIRPTA to either withhold the necessary FIRPTA tax or obtain a necessary exemption form to avoid withholding. The buyer must withhold the 15% withholding tax when FIRPTA withholding applies on the amount realized. The amount realized is either the cash paid, the fair market value of the property or the amount assumption of the liability on the real property immediately before and after the transfer.
If the real property is owned jointly by US and foreign persons, the amount realized is allocated between the transferors based on the capital contributed by both the foreign and US transferor under the FIRPTA rules.
Does FIRPTA Allow an Exception to Withholding?
There are a number of specific exceptions to FIRPTA withholding.
The purchaser acquires the property for use as a personal residence, the property is acquired for not more than $300,000, and family members intend and do use the property for more than 50% of the days of the year.
The sale of property relates to the sale of publicly traded US stock.
The sale of US stock and the US corporation certifies the sale is not the sale of a US real property interest.
The transferor certifies that it is not a foreign person, including the US taxpayer ID and address.
The transferor provides a certificate from the IRS that excuses withholding.
If you have questions or concerns about possible FIRPTA application to a real property transaction, contact Steiger Tax Law for a free consultation. Failing to properly withhold FIRPTA tax could result in significant tax exposure to the buyer.