The Foreign Investment in Real Property Tax Act (FIRPTA) is one of real estate’s most important yet overlooked tax laws. While FIRPTA does not impact most property transactions, it adds several critical steps to the transactions it affects. Specifically, it applies to any real estate transaction in which a foreign nonresident sells property in the U.S.
FIRPTA applies to more transactions in Florida than in many other states due to its fame as a vacation location. If you are buying or selling property in Florida, it is worth understanding how FIRPTA works to ensure you know your potential obligations.
What Is FIRPTA?
The United States government implemented the Foreign Investment in Real Property Tax Act in 1980 after a trend of foreign nationals purchasing U.S. real estate. The purpose of FIRPTA is to regulate and tax investors from other countries operating within the U.S.
At a basic level, FIRPTA requires foreign investors to pay taxes whenever they sell real estate and make a capital gain in the U.S. However, the specific regulations regarding how tax must be paid and what reporting requirements must be met vary depending on the circumstances. It is essential to answer several questions to determine whether and how the law will impact the transaction:
- Is the seller a U.S. person or a foreign person? FIRPTA only applies if the seller is considered a “foreign person,” including private individuals and organizations. However, coming from outside the country is not enough to be regarded as a foreign seller. In general, foreign persons are defined as “nonresident aliens,” and foreign corporations not treated as domestic corporations. If a company operates domestically or a non-citizen has lived in the country for at least 183 days over the past three years, they may be considered a U.S. person, and FIRPTA does not apply.
- How much gain will be realized on the sale? FIRPTA specifically taxes the amount realized by the seller in a sale of real property. In most cases, this is the sale price of the home. However, in certain circumstances, it may be less, such as if certain exemptions apply or if the seller only owns a partial interest in the property.
- How much money should be withheld? Two withholding rates may apply to these transactions. Properties worth less than $300,000 do not face withholdings if they will be used as the buyer’s primary residence. Properties worth between $300,000 and $1 million used as primary residences face a 10% tax. Properties worth more than $1 million or that will not be used as your primary residence are always taxed at 15%. The buyer is responsible for withholding these funds, so calculating them correctly upfront is critical.
How FIRPTA Affects Real Estate Sellers and Buyers
If you meet the definition of a non-residential alien, FIRPTA will seriously affect any real property sales you perform. Depending on the sale price of your property, you could face withholdings of 10% to 15% of the entire sale. Selling commercial property for $1 million could lead to a withholding of $150,000, though some of that will likely be returned with the tax return. Considering this tax when buying or selling properties in the U.S. is essential to minimize tax-related losses.
In addition, sellers share responsibility for ensuring the law is followed. If you have any reason to believe you may be considered a nonresident alien, you should consult an experienced real estate attorney before putting a property up for sale. Your attorney will determine if the law applies and help you set the terms of the sale to minimize your losses.
FIRPTA also impacts buyers of affected properties. Buyers are obligated to withhold the tax funds at the time of sale and deliver them to the IRS within 20 days. Failing to withhold the correct amount can leave the buyer liable for the entire withholding amount. As such, it is just as important for buyers to calculate accurate and complete withholding as it is for sellers.
How to Comply With FIRPTA
Complying with FIRPTA is a complex and time-consuming process. It starts when the buyer and seller begin the transaction.
Normally, a seller signers a document known as a FIRPTA affidavit, or an Affidavit of Non-Foreign Status, to confirm that they are a U.S. resident or entity. However, in FIRPTA transactions, these affidavits cannot be honestly signed. Anyone buying real estate in Florida should confirm that the seller has provided a signed affidavit, or they may be liable for the tax amount. Furthermore, sellers who offer false affidavits can be penalized as well.
The buyer and seller must calculate the withholding if no affidavit is provided. The value of the property and the buyer’s intent dictate how much this withholding will be. The buyer will retain this withheld amount and send the funds to the IRS alongside two forms:
- Form 8288: U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests
- Form 8288-A: Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests
The amount sent to the IRS will be used to cover any taxes the seller owes on the sale. The remainder will be returned to the seller with their tax return if they file taxes in the U.S.
Experienced Legal Counsel for Real Estate and FIRPTA Transactions
Calculating the exact amount to withhold from a FIRPTA sale can be complicated, and penalties can be significant. If you are considering buying real estate from or selling property as a foreign nonresident, discussing your needs with an experienced real estate attorney is crucial. At Isriel Ponzoli, we specialize in providing our clients with expert legal representation in real property transactions. Learn more about how we can assist you by scheduling your consultation today.