Foreign Investment In Real Property Tax Act (FIRPTA)

May 20, 2021

FIRPTA

On September 14, 2020 the IRS Large Business & International Division (LB&I) announced an IRS audit campaign to increase Non-Resident Alien (NRA) compliance with the complex U.S tax rules relating to U.S. real property transactions. This particular campaign targets the non-compliance of NRA’s in connection with the withholding of tax and  reporting obligations on the disposition of U.S real property interests under the Foreign Investment In Real Property Tax Act of 1980 (FIRPTA).

The purchase of U.S. real estate by foreign nationals is a major source of investment in the United States. Property sales to foreign buyers in 2019 & 2020 totaled around $78 Billion in each year. Therefore, it is not surprising that the IRS is targeting compliance in this area.

FIRPTA was enacted to ensure that foreign investors pay U.S federal income tax on the sale or disposition of U.S real property interests (USRPI).

Tax levied under FIRPTA is initially collected through withholding and the obligation to withhold is placed on the purchaser, rather than the seller of the USRPI. Unless an exemption applies, the purchaser is  required to withhold 15 percent of the total purchase price if the seller of the property is a foreign person. The three most common FIRPTA  exemptions are:

  • The seller is a U.S Taxpayer (a U.S citizen, green card holder, or “Substantial Presence” taxpayer).
  • The 15 percent withholding tax exceeds the maximum tax liability in which case the seller can apply for a withholding certificate to reduce the withholding to the maximum amount of tax due.
  • The purchase price of the real property is not more than $300,000 and the purchaser intends to reside in the property for at least 50 percent of the time for the first 24 months following the closing.

The 15 percent withholding tax has no correlation to the actual amount of U.S tax due on the sale of the real property, and even if an exemption may apply to eliminate the withholding tax requirement, that does NOT impact on the seller’s requirement to files a U.S federal income tax return and pay U.S federal (and perhaps State) tax on the gain derived from the sale. The withholding tax requirement ensures that U.S tax will be collected and gives NRA’s an incentive to file appropriate tax returns to report income from the sale and claim a credit for the withheld funds, particularly if the withheld tax exceeds the actual U.S tax due.

For a disposition of U.S real property interest subject to the FIRPTA  regime, the purchaser is required to file Form 8288 (U.S Witholding Tax Return for Dispositions by Foreign Persons of U.S Real Property Interests, and 8288-A, Statement of Witholding on Dispositions by Foreign Persons of U.S Real Property Interests, together with payment of the withheld tax by the 20th day following the sale). After receiving the submitted forms, the IRS will stamp Form 8288-A to acknowledge receipt of the withheld tax and send a copy to the seller for include with their tax return filing.

In addition to the Form 8288 and 8288-A filing requirements, the NRA seller must also file a U.S Federal Income Tax Return – Form 1040NR  (U.S Non-Resident Alien Income Tax return), reporting the sale and paying the actual tax due on the gain (calculated using the applicable graduated tax rates) or requesting a tax refund to the extent that the withheld amount is more than the tax due.

Apart from the FIRPTA taxation regime that applies to the disposition of U.S real property interests, NRA’s that are not in a U.S trade or business in connection with the rental property and file the appropriate W-8 form are subject to a 30 percent U.S Witholding tax imposed on the gross amount of the rents received (i.e – without the benefit of deductions), unless a “871d election” is made under the Internal Revenue Code. The benefit of making the net election is to treat the rental income as effectively connected with the conduct of a U.S trade or business, which enables the NRA to reduce the gross rental income by attributable deductions, including operating expenses, interest and depreciation provided that a true and accurate U.S federal income tax return is timely filed. In that case, the net income would be subject to U.S tax at ordinary tax rates which may be beneficial compared to the 30 percent withholding tax on the gross amount of rental income.

It is recommended that NRA investors in advance of a purchase of U.S Real Estate seek appropriate U.S tax advice with respect to the acquisition, operation, and disposition of U.S real property interests.

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