How to avoid FIRPTA tax? and how to avoid withholding requirement?
Member since 2023 · 7 posts · 0 votes
How to avoid FIRPTA tax? and how to avoid withholding requirement?
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Qualified Intermediary for 1031 Exchanges · Greater Detroit, MI · Member since 2023 · 14 posts · 7 votes
2yAs @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.
8 Replies
- 2yMelanie P.Pro MemberRental Property Investor · Member since 2023 · 1k+ posts · 922 votes
How is title to the property held now?
You can do a 1031 exchange if the property has corporate ownership and the corporation has filed or will file a US Income Tax return. Do note that when the corporation one day decides to return money to the foreign person it will be required to make the FIRPTA withholding and pay its own taxes on any income the property generates.
Individuals can also complete Form 8828-B for a withholding certificate relieving the seller of the duty to withhold FIRPTA. This process has some problems: it takes a few months to get a response from the IRS and you have to submit a copy of the contract for the replacement property with the notice that the seller intends to complete a 1031 exchange.
- 2yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@James Bakun, A simultaneous exchange is the only other option other than what @Melanie P. laid out. The general interpretation of simultaneous for purposes of the 1031 is that both sale and purchase are under contract and close within a day or two of each other with the funds being sent directly from the sale to the purchase escrow. I don't know if an additional day or two might help you.
FIRPTA is a tough nut to crack for foreign investors wanting to take advantage of a 1031 exchange.
The 1031 Investor5137 Reviews - Qualified Intermediary for 1031 Exchanges · Greater Detroit, MI · Member since 2023 · 14 posts · 7 votes2y
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.
- Member since 2023 · 7 posts · 0 votes2y
@Melanie P. Unfortunately they are not in corporate ownership. They own the properties in their personal names.
@Dave Foster @Dylan Johnson Hypothetically, they would send Form 8828-B for withholding certificate on the same day the property is under contract (with closing 90 days after acceptance to give IRS enough time to process). Do they need to include the "notice that seller intends to complete a 1031 exchange" with Form 8828-B?
When does the IRS need the replacement property contract? Ideally we need the IRS to approve exemption first in order for us to include the "withholding" amount to the replacement property offer price?
- Qualified Intermediary for 1031 Exchanges · Greater Detroit, MI · Member since 2023 · 14 posts · 7 votes2y
Form 8828-B would need to be filed by the clients CPA preferably and the CPA would be able to advise on all the relevant information to include with the form. My understanding is the form itself is alerting the IRS to the plans of a 1031 exchange.
The IRS is only looking for a copy of the relinquished property sale contract, they don't necessarily need the contract for replacement property right away as the FIRPTA exemption needs to be approved prior to the closing on the sale of relinquished property.
Once the exchange is completed the CPA will report all necessary information relevant to the exchange at tax year end.
- 2yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@James Bakun, That's the theory. The reality - I've seen very very few 90 day turnarounds in years. That's the problem with the 8828. But if that's your only option then it's worth it to try it. Just be prepared for plan b - withholding firpta if the certificate does not get back.
The 1031 Investor5137 Reviews - Member since 2023 · 7 posts · 0 votes2y
Thanks all! Based on your responses, the safest route to avoid FIRPTA tax is to do a simultaneous exchange. I personally don't feel comfortable waiting for the IRS to "maybe" approve the 8288-B.
It seems nearly impossible selling 2 relinquished properties and purchasing 1 replacement. With that said, they will unfortunately have to only sell 1 relinquished and purchase 1 replacement to avoid the risk of FIRPTA :-(
Do they have to submit anything to the IRS when the relinquished property is under contract? How do we explain to the buyer that there is no need for 15% withholding because they are closing on a replacement property the same day?
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