FIRPTA Explained: The US Tax Trap for Foreign Property Sellers

For most non-US residents selling property in the United States, FIRPTA is not an additional tax but a mandatory withholding of 15 percent of the gross sales price to ensure compliance with capital gains obligations. This withholding is collected by the Internal Revenue Service (IRS) at the time of closing and is often significantly higher than the actual tax owed.

Key takeaways

• Standard Withholding: The IRS generally requires 15 percent of the gross sale price to be withheld at the point of sale.
• Gross vs Net: Withholding is based on the total sale price, not the profit or capital gain.
• Exemptions Exist: Properties sold for less than $300,000 as a primary residence for the buyer may be exempt.
• Withholding Certificates: Sellers can apply for a reduction or waiver if they can prove the tax liability is less than the withholding amount.
• Compliance is Mandatory: The buyer (transferee) is legally responsible for ensuring the funds are withheld and remitted.

What exactly is FIRPTA?

FIRPTA stands for the Foreign Investment in Real Property Tax Act of 1980. Before this legislation, foreign investors could sell US real estate and exit the country without paying capital gains tax, leaving the IRS with no recourse to collect. To prevent this, the US government shifted the burden of tax collection to the buyer.

Under FIRPTA, when a "foreign person" sells a US real property interest, the buyer must withhold a percentage of the amount realised from the sale. While the standard rate is 15 percent, it is a common misconception that this is the tax rate itself. It is merely a deposit toward the seller's final US income tax liability for the year.

Who is considered a "foreign person" under FIRPTA?

For the purposes of this legislation, the IRS defines a foreign person as a non-resident alien individual, a foreign corporation, a foreign partnership, or a foreign trust.

It is important to note that United States citizens and Green Card holders (permanent residents) are not subject to FIRPTA withholding. Non-residents who meet the "Substantial Presence Test" for tax purposes may also be exempt, though they will still be taxed on their worldwide income by the US.

How much is withheld during a property sale?

The amount of FIRPTA withholding depends on the purchase price and the intended use of the property.

1. Sale price up to $300,000: If the buyer intends to use the property as a residence for at least 50 percent of the time it is in use during the next two years, the withholding is 0 percent.
2. Sale price between $300,001 and $1,000,000: If the buyer intends to use the property as a residence, the withholding rate is reduced to 10 percent.
3. Sale price over $1,000,000: The full 15 percent withholding applies regardless of the buyer's intended use.
4. Corporate Sellers: If the seller is a foreign corporation, the withholding rate is generally 21 percent of the gain recognised on the distribution of the property.

Why is FIRPTA called a "tax trap" for HNWIs?

High-Net-Worth Individuals (HNWIs) often find themselves in a liquidity crunch due to FIRPTA. Because the 15 percent is calculated on the gross sales price, it can easily exceed the actual profit made on the sale.

For example, if an investor sells a Miami penthouse for $5,000,000 that they originally purchased for $4,800,000, their capital gain is only $200,000 (excluding costs). However, the FIRPTA withholding would be $750,000 (15 percent of $5 million). This means the seller must wait until they file a US tax return the following year to claim a refund for the overpayment. For many, having large sums of capital tied up with the IRS for 12 to 18 months is a significant opportunity cost.

Can I reduce or avoid FIRPTA withholding legally?

Yes, there are formal mechanisms to mitigate the impact of FIRPTA, but they require advanced planning.

The Withholding Certificate (Form 8288-B)

The most common method is applying for a Withholding Certificate via IRS Form 8288-B. By filing this before or on the date of closing, the seller can request a reduction in the withholding amount based on the actual estimated tax due. If the IRS approves the certificate, the settlement agent can hold the funds in escrow rather than sending them to the IRS. Once the certificate is issued, the agent releases only the required tax amount to the IRS and returns the balance to the seller.

Non-Foreign Affidavit

If the seller is actually a US resident for tax purposes, they can provide a "Non-Foreign Affidavit" under penalty of perjury. This document contains the seller's US Taxpayer Identification Number (TIN) and address, which exempts the buyer from the requirement to withhold.

What is the buyer's role in this process?

In a standard real estate transaction, it is the buyer's legal responsibility to withhold the funds. If a buyer fails to withhold the required 15 percent and the foreign seller fails to pay their taxes, the IRS can hold the buyer liable for the tax. Consequently, title companies and closing attorneys are extremely diligent in ensuring FIRPTA compliance to protect the buyer.

What are the reporting requirements?

When withholding occurs, the buyer must file Form 8288 and Form 8288-A with the IRS. These forms report the amount withheld and the details of the transaction. The IRS will process these and send a stamped copy of Form 8288-A back to the seller. This stamped copy is essential; the seller must attach it to their US income tax return (Form 1040-NR) to receive credit for the funds withheld.

How does FIRPTA impact corporate structures?

Many international investors hold US property through US-based Limited Liability Companies (LLCs) or foreign corporations. The rules here are complex:

• Single-Member LLC: If a foreign individual owns a US LLC that holds the property, the LLC is usually treated as a "disregarded entity." The sale is treated as being made by the foreign individual, and FIRPTA applies.
• Domestic Corporation: If the property is owned by a US corporation that is owned by foreign shareholders, FIRPTA typically does not apply at the point of sale. However, the corporation itself will pay US corporate income tax on the gain.

Professional advice from a specialist tax attorney is vital when using corporate vehicles, as the Foreign Investment in Real Property Tax Act often intersects with other sections of the Internal Revenue Code, such as Section 897.

Common mistakes to avoid

1. Waiting until closing: Applying for a withholding certificate on the day of closing is often too late to avoid the initial cash flow impact.
2. Calculating on gain, not price: Miscalculating the 15 percent based on profit instead of the sale price leads to legal delays at the closing table.
3. Missing Taxpayer IDs: Both the buyer and seller must have a US Taxpayer Identification Number (TIN or ITIN). If the seller does not have one, the application for an ITIN should be submitted alongside the FIRPTA forms.

Conclusion

While FIRPTA is a significant hurdle for non-US residents selling property, it is a manageable one. By understanding the withholding thresholds and utilising the 8288-B application process, sellers can protect their liquidity and ensure they only pay the tax truly owed. To ensure compliance and maximise returns, foreign investors should engage an experienced US tax professional well before listing their property for sale.

FAQ

Is FIRPTA a final tax? No, it is a withholding (prepayment) towards your final tax bill. You must still file a US tax return to determine the actual tax owed.

How long does it take to get a FIRPTA refund? If you do not apply for a withholding certificate, you must wait until you file your annual tax return (usually the following year). Refunds typically take 6 to 12 months to process after the return is filed.

Does FIRPTA apply to inherited property? Yes, if a foreign person inherits US property and later sells it, the sale is subject to FIRPTA rules based on the value at the time of the sale.

Can I avoid FIRPTA by using a 1031 Exchange? Yes, it is possible to use a Section 1031 Exchange (like-kind exchange) to defer both the tax and the withholding, but you must strictly follow IRS procedures and ensure the buyer is provided with a notice of non-recognition.

What if the property is sold at a loss? Even if you sell at a loss, the 15 percent withholding still applies unless you successfully apply for a Withholding Certificate from the IRS proving that no tax is due.

Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a qualified tax professional or legal advisor regarding your specific situation.