The disposition of a U.S. real property interest by a foreign seller (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. Persons purchasing U.S. real property from foreign sellers are required to withhold and remit 15% of the amount realized on the disposition (i.e., typically the sales price).
Below we’ll review the steps in determining whether a transaction is covered by FIRPTA.
Step 1: Is it a U.S. real property interest?
A U.S. real property interest is an interest, other than as a creditor, in real property (including an interest in a mine, well, or other natural deposit) located in the United States or the U.S. Virgin Islands, as well as certain personal property that is associated with the use of real property (such as farming machinery). It also means any interest, other than as a creditor, in any domestic corporation unless it is established that the corporation was at no time a U.S. real property holding corporation during the shorter of the period during which the interest was held, or the 5-year period ending on the date of disposition (applicable periods).
In most contexts, a U.S. real property interest would be a residential or commercial property.
Step 2: Is the seller a non-U.S. person?
Withholding on a real estate transaction is required only if the seller is a non-U.S. person. IRC 7701 defines a “U.S. person” as one who meets any one of the following requirements:
- Is a United States citizen;
- Is a lawfully admitted permanent resident (“green card” holder); or
- Meets the substantial presence test
A person meets the substantial presence test if they are present in the U.S. for at least 31 days during the current year, and the sum of the days in which the individual is present is greater than 183 days for the current year and 2 preceding years using the applicable multiplier:
|In the case of days in:
|The applicable multiplier is:
1st preceding year
2nd preceding year
There are exceptions to the substantial presence test:
- Closer connection to a foreign country
- An exclusion of any days where an individual was unable to leave the U.S. because of a medical condition which arose while such individual was present in the U.S.
- Individuals who are exempt under IRC 7701(b)(5), which include: a foreign government-related individual, a teacher or trainee, a student, or a professional athlete who is temporarily in the U.S. to compete in a sports event.
Step 3: Rates of withholding
After it is determined that the transferor (seller) is a foreign person, the applicable withholding amount must be determined.
First, an exception (as always in the tax code): No withholding is required under section 1445(a) if one or more individual transferees acquire a U.S. real property interest for use as a residence and the amount realized on the transaction is $300,000 or less. In other words, if the buyer intends to use the property as a residence and the amount realized (generally the purchase price) is less than $300,000, there is no withholding requirement.
Otherwise, the transferee (buyer) must deduct and withhold a tax on the total amount realized by the foreign person on the disposition. The rate of withholding generally is 15% (10% for dispositions before February 17, 2016).
The amount realized is the sum of:
- The cash paid, or to be paid (principal only);
- The fair market value of other property transferred, or to be transferred; and
- The amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.
Warning to buyers! If the seller is a foreign person and you fail to withhold, you may be held liable for the tax.
We assist parties in real estate transactions that are subject to FIRPTA. Contact us to see how we can help.