The Foreign Investment in Real Property Tax Act (FIRPTA) was enacted in 1980 in order to impose a tax withholding requirement on foreign persons disposing of U.S. real property interests (USRPI). If you are a foreign person with investments in U.S. real estate, or are considering investing in U.S. real estate, here are things you need to know about FIRPTA.
Why was FIRPTA Passed?
Unlike U.S. persons who are taxed on worldwide income, foreign persons are only subject to tax on income that is effectively connected (ECI) with U.S. trade or business. Foreigners are also taxed on certain fixed income known as FDAP.
When a foreign person disposes of U.S. real property, any resulting gain from the sale is considered effectively connected income and is taxable in the U.S. It would be difficult to enforce U.S. tax law against a foreign person that does not reside in the U.S. There would be little the IRS could do enforce voluntary tax compliance against an individual that does not reside in the U.S. In order to ensure tax compliance, FIRPA was created to require a mandatory tax withholding for foreign persons that disposes of U.S. real property.
How are Taxes Withheld Under FIRPTA?
When a seller purchases U.S. real property from a foreign person, he is required to withhold 15% of the sales price. The 15% is an increase from 10% that went into effect on February 17, 2016. The withheld amount is then reported on form 8288-A and filed with the IRS.
Exceptions Under FIRPTA
There are several important exceptions that allow for reduced withholding or eliminate the withholding requirement altogether.
If the seller provides a FIRPTA affidavit that he is a U.S. person, then the withholding requirement will not apply. A U.S. person can be a U.S. Citizen, permanent resident, or a taxpayer that meets the substantial presence test.
If the buyer purchases the property as a personal residence and the value of the property does not exceed $300,000, then there will be no withholding requirement. Or if the same applies but the value of the property is between $300,000 and $1,000,000, then the withholding amount will be reduced to 10% of the sales price.
If none of the above exceptions apply, then the seller can seek to have the withholding reduced upon certification by the IRS that a reduced withholding amount applies. A seller can apply for the FIRPTA certification by filing Form 8288-B, no later than the closing date of the sale.
Special Rule for Partnerships
For domestic partnerships owned by foreign partners, there is an increased withholding requirement when the partnership disposes of a U.S. real property interest. In such event, the partnership is required to withhold 35% of the gain realized and allocable to the foreign partners.
Additionally, withholding is required of a purchaser of a partnership interest where 50% or more of the partnership’s gross assets consist of U.S. real property interests and 90% or more of the value of the partnership’s gross assets consist of U.S. real property interests plus cash and cash equivalents.