Real Estate Investing Foreigners FIRPTA + Real Estate
What is FIRPTA?
It is the Foreign Investment in Real Property Tax Act of 1980. This act enables the IRS to collect potential income tax revenue from foreigners investing in real estate and other real property at the time the property is transferred (i.e. sold). The transfer agent, (typically a title company), has a requirement to withhold the potential income tax from the closing proceeds and remit those withholdings to the IRS.
When does FIRPTA apply for real estate transactions?
FIRPTA applies to a foreigner seller when real estate is sold. It does not apply to a foreigner buyer at the time of purchase.
How much tax is withheld?
The withholding rate is different for individuals, partnerships and corporations. For individuals, the withholding rate is 15% of the total amount realized by the seller. The amount realized is generally the gross sales price of the property being sold. By way of example: Joe Smith bought his property for $450,000US and is now selling it for $475,000US. According to FIRPTA, the title company must withhold $47,500 – 15% of the gross selling price even though the actual profit made by the seller is only $25,000US.
Foreign corporations are subject to a thirty-five percent (35%) withholding rate. Partnerships are slightly more complicated because the withholding rate is subject to the effective income of the foreign partners.
What is a withholding certificate?
A withholding certificate is a document issued by the IRS upon application of the seller to have the amount of withholding reduced. There are six basic categories of applications. Generally, the category applicable to individual foreigner investors is based on a calculation of the seller’s maximum tax liability. With the example above, Joe Smith would recognize $25,000 in profit. Submitting a withholding certificate application documenting the calculation of this profit could result in the issuance of a withholding certificate reducing the amount of tax withheld from the previous calculation of $47,500 to $2,500 resulting in an immediate cash savings of $45,000. The process to obtain a withholding certificate can be cumbersome and it is recommended that you seek the advice and service of a licensed professional.
What forms will be required?
- W-7/W-7SP: Individual Taxpayer Identification Number application
- 8288/8288-A/8288-B: Application for Withholding Certificate for Disposition by Foreign Persons of U.S. Real Property Interest.
- HUD-1: Closing statements for purchase/sale of property
- 2848: Power of Attorney
- Detailed calculation of maximum tax liability
- Letter of explanation