Can I do a 1031 exchange as a foreign investor?

Question

Hey everyone . Quick question, I'm Canadian and recently sold property in AZ. I'm now buying a more expensive property in California. I'm wondering if I can do a 1031 exchange or is this only for residents?

Thank you

Bill Exeter · Answer

Hi @Akash Y.,

This does not necessarily apply to you and your situation, but I thought I would add this for the benefit of other readers. The IRS has recently changed the way that you apply for a Certificate of Withholding Exemption that will affect your 1031 Exchange transaction. You used to be able to apply concurrently with the IRS for an ITIN and the Certificate of Withholding Exemption.

Today, you must first apply for and obtain your ITIN, and then once you have received your ITIN you can then apply for your Certificate of Withholding Exemption. In addition, you must provide the IRS with information, including copies of the contracts, for the sale of your relinquished property as well as the purchase of your replacement property.

Unfortunately, this complicates a 1031 Exchange transaction because investors often do not know what replacement property they will be acquiring let alone having it under contract. So, in many cases, the investor will have to begin the process of applying for and obtaining an ITIN, and subsequently applying for the Certificate of Withholding Exemption, while they are in the process of closing on the sale of the relinquished property. There sale of their relinquished property will often close before they have obtained the required Certificate of Withholding Exemption, which means that the required withholding amount must be withheld at the close of the transaction.

It is important for the investor to select a closing agent that is willing to withhold but not remit the required withholding amount so that the investor has sufficient time to complete and obtain their Certificate of Withholding Exemption and thereby allowing the closing agent to release the required withheld amount to the Qualified Intermediary so that 100% of the cash proceeds can be used toward the purchase of the investors replacement property.

If the required withheld amount cannot be used toward the purchase of the replacement property, the investor can still contribute out-of-pocket funds into the closing/1031 Exchange in order to "fund" the withholding in order to allow 100% of the net cash proceeds to be used toward the purchase of their replacement property. Investors that are not in a position to contribute out-of-pocket funds will be subject to tax on the amount withheld since it was not used toward the purchase of their replacement property.

Bill Exeter · Answer

I also realized that I did not address the simultaneous closing topic.  There is a special exception to the FIRPTA withholding requirements when the sale of the relinquished property closes concurrently/simultaneously with the closing of the replacement property and there is no taxable boot involved.

However, it requires that all of the parties involved have taxpayer identification numbers (which is generally not the case with foreign sellers) and it requires the buyer of the relinquished property to sign a notice at closing that is sent to the IRS stating that there are no withholding obligations because all of the conditions for the exception have been met.

Remember, it is technically the buyer's responsibility (not the closing agent) to withhold, but they generally delegate the withholding process to the closing agent.  Buyers who understand what they are being asked to sign will usually not sign the notice, so the seller will still have to go through the process described above.

Dave Foster · Answer

We only perform 1031 exchanges.  But we are a nationwide service and we work with foreign investors.  The IRS requires that the qualified intermediary for a 1031 be an unrelated 3rd party so we can't perform multiple roles for the client.

Nice catch on the other firpta exception - the sale to an owner occupant where the sale is less than $300K.

Akash Y. · Answer

Hi David

Thanks for clearing this up. I guess I didn't initiate the 1031 before the sale of the first properties. I now know for next time.

I actually avoided firpta because  I sold to someone who was going to use the home as a primary residence and sale price was under 300k.

Do you do 1031 exchanges or taxes for foreigners? You seem to have more knowledge than the average person and I'm looking for someone assistance going forward.

Thank you

Dave Foster · Answer

@Akash Y. the 1031 exchange can be a powerful tool for the foreign investor to avoid the withholding required under FIRPTA.  There are two ways that it can work for you - either through simultaneous exchange where both sale and purchase happen concurrently to the satisfaction of the selling escrow company.  The other option is if you first obtain a certificate of non-withholding that exempts you from FIRPTA withholding as you complete a regular deferred 1031 exchange.

Even if you cannot do a simultaneous exchange and fail to get a withholding certificate in time you can still complete the 1031 exchange and report a sale with a non-recognition of gain on your next tax filing.

But if you mean that you recently closed on a sale then you're opportunity to complete a 1031 exchange is over.  A qualified intermediary must be in place and the sale documented as a 1301 exchange with you not touching the proceeds in order to be valid.

Can I do a 1031 exchange as a foreign investor?

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