How to avoid FIRPTA tax? and how to avoid withholding requirement?

[James Bakun]

Hello, I have foreign clients who own investment real estate in the U.S. They are looking to sell and would be subject to FIRPTA tax. Is there a way to avoid paying this? and is there a way to avoid the withholding requirement?

Keep in mind:

#1) they are doing a 1031 exchange (selling 2 relinquished, and purchasing 1 replacement)

#2) sale price is over $300,000.

#3) it is almost impossible for them to do a simultaneous exchange on the same day.

[Dylan Johnson]

As @Dave Foster said FIRPTA is a tough nut to crack. Everything aforementioned is great information, I just wanted to provide a little extra color in the hopes it assists your client's decision. The below is information put together by David Gorenberg, J.D., one of our subject matter experts. 

US Real Estate Ownership Among Foreign Citizens

According to the Congressional Research Service, foreign citizens own 3% of all US real estate, with investors from Canada, Netherlands, and Italy accounting for about half of that. As of 2019, the states with the highest number of foreign-owned acres were Texas (4.4 million acres), Maine (3.3 million acres), Alabama (1.8 million acres), and Washington and Colorado (1.5 million acres each). Arkansas, California, Florida, Georgia, Louisiana, Michigan, New Mexico, Oklahoma, and Oregon each report approximately 1 million acres owned by foreign citizens. What happens when these foreign owners want to sell their US real estate?

What is FIRPTA?

The disposition of any interest in US real property by a foreign taxpayer is subject to the Foreign Investment in Real Property Tax Act of 1980, commonly known as FIRPTA, income tax withholding. In short, what this means for the foreign seller of a US Real Property Interest is that the buyer of that interest must withhold 15% of the purchase price at the time of the sale. This applies to all transfers by foreign taxpayers – whether by sale, exchange, liquidation, redemption, gift, or otherwise. The recipient of the property – the buyer, transferee, purchasers’ agents, and settlement officers are tasked with holding back 15% of the purchase price, rather than paying it directly to the foreigner investor. If the transferor were a foreign taxpayer, and  the Buyer or settlement officer, fail to withhold those funds, they could be held liable for the tax.

FIRPTA withholding does include exceptions to the withholding rules. As applied to 1031 exchanges, the most relevant exceptions that allow you to disregard FIRPTA include:

• You (the Buyer) are going to be using the property as your principal residence, and the fair market value is less than $300,000
• The Seller provides you with a Certificate of Non-Foreign Status (meaning that FIRPTA does not apply)
• If the foreign Seller obtains a FIRPTA Withholding Certificate by filing Form 8288-B.

It is important to note that the foreign Seller cannot submit the Form 8288-B until there is a valid real estate contract. The completed form should be submitted to the IRS promptly, and before the actual closing date on the sale. Any form submitted after the closing date will be deemed by the IRS to be untimely and require that the mandatory withholding amount be sent to the IRS within 20 days of the closing date.

As a practical matter, all of this has two key impacts:

• 1031 exchange Buyer of a foreign person’s real estate – As the 1031 exchange Buyer of a foreign person’s real estate, you would be required to withhold 15% of the fair market value of the real estate, typically the purchase price, at the time of closing. More often than not, this task is completed by the settlement agent or escrow agent, but a prudent buyer would ensure compliance.
• Foreign investor selling as part of a 1031 exchange – When the foreign investor is selling as part of a 1031 exchange, that investor is advised to submit Form 8288-B as soon as they have a contract for the sale of that property. If the 8288-B is not submitted before closing, the Buyer will be required to withhold, and to then remit, the 15% to the IRS by the 20th day after closing. It typically takes the IRS up to 90 days to process requests for refunds or exemptions using Form 8288-B.

Buyers, closing agents, and Qualified Intermediaries such as Accruit are required to comply with FIRPTA withholdings. Whether you are a 1031 exchange buyer of a replacement property from a foreign taxpayer, or you are a foreign investor selling as part of a 1031 exchange, you should consult with your tax or legal advisors well in advance of the closing.