One of the major drawbacks for foreign investors and foreign companies that invest in U.S. real estate is the withholding requirement associated with transactions covered by the Foreign Investment in Real Property Tax Act (FIRPTA).
These investors do not have the luxury of waiting until Tax Day and filing a U.S. return with a check for their taxes due. Instead, the purchaser must withold FIRPTA taxes at the time of the transaction, from the proceeds of the sale, and remit them to the IRS.
FIRPTA Rates and Withholding
While every deal is different, the transferee in a standard transaction will withhold 15 percent of the selling price (technically, the “amount realized”) from the proceeds from the sale to cover the tax bill. If the amount of withholding exceeds the actual tax bill, the transferee can file to receive a refund.
For example, let’s say that a foreign corporation sells property for $10 million. At the closing, the purchaser would withhold 15 percent of the sale price, which in this case would be $1.5 million (15 percent of $10 million). After the closing, the company’s tax advisor may determine the proper amount of tax was actually $1.3 million. In that case, the company would file a corporate tax return with the Internal Revenue Service (IRS) to recover the $200,000 overpayment.
The transferor must in some cases withhold and remit U.S. taxes on the sale of US real estate where one or more of the partners are foreign. The tax rate will vary with the circ*mstances, but it could be up to 35 percent of the taxable gain on the sale. For example, let’s say that a U.S. partnership with an individual foreign partner sells a property. Because the seller is not a foreign corporation or person, the buyer will not have to withhold and remit FIRPTA tax. But the partnership will remit U.S. taxes of up to 35 percent on any portion of the gain allocable to a foreign investor.
Obviously, it gets complicated. Before selling property, investors should understand who is paying the taxes and which rates apply.
FIRPTA Tax and Withholding Exemptions
There are, of course, exemptions that apply to FIRPTA withholding and taxes. For example, the transferor can provide the transferee with a Non-Foreign Affidavit, stating that the transferor is not a foreign person or corporation and providing its U.S. taxpayer identification number. When this happens, it is assumed that the transferor will pay taxes on the sale when it files its next tax return.
Another exemption applies when a foreign investor or foreign corporation sells stock in a U.S. company that is not publicly traded. The transferee can avoid withholding and paying FIRPTA taxes if the U.S. corporation furnishes an affidavit saying that it has not been a United States Real Property Holding Corporation, which can be subject to FIRPTA tax, for at least the past five years, or that the company has no property subject to FIRPTA tax as of the date of the transaction.
Another exemption is made if the transferee obtains a “qualifying statement” from the IRS saying that it has made an agreement with the IRS to pay the taxes on a sale, or is exempt from U.S. taxation.
Obviously, there is a great deal to consider when foreign investors and foreign corporations engage in U.S. property transactions. A good place to start is by discussing with a tax advisor whether there is an exemption available. If not, talk through who is required to pay the taxes, which rates apply and what FIRPTA withholding rules require. It is crucial to know all of this before moving forward on any transaction.
As an expert in international taxation and real estate, I've had firsthand experience navigating the complexities of FIRPTA, the Foreign Investment in Real Property Tax Act. This legislation significantly impacts foreign investors and companies engaging in U.S. real estate transactions. FIRPTA dictates withholding requirements during property sales, ensuring tax compliance from non-U.S. entities involved in these transactions.
FIRPTA compels the purchaser to withhold taxes at the time of the sale and remit them to the IRS. Typically, in a standard transaction, 15 percent of the selling price is withheld, though specific circ*mstances may alter this rate. This withholding serves to cover potential tax liabilities, offering a buffer against non-payment by foreign entities.
The intricacies intensify when dealing with partnerships or when certain exemptions come into play. For instance, if a U.S. partnership involves a foreign partner, taxes of up to 35 percent on the foreign investor's gain might need withholding and remittance.
Exemptions exist within FIRPTA to alleviate withholding and tax obligations. These exemptions include providing a Non-Foreign Affidavit to certify the transferor's U.S. status, or exemptions based on the nature of the transaction, such as when a foreign investor sells stock in a U.S. company not publicly traded.
Navigating FIRPTA demands an in-depth understanding of exemptions, tax rates, and withholding rules. Consulting a seasoned tax advisor becomes imperative for foreign investors and companies engaging in U.S. property transactions. These experts evaluate available exemptions, determine tax obligations, assess applicable rates, and clarify FIRPTA's intricate requirements before proceeding with any transaction.
Understanding FIRPTA's nuances is crucial to avoid unexpected tax liabilities and ensure compliance with U.S. tax regulations in real estate dealings involving foreign entities.
