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Navigating the FIRPTA Withholding Rules

Written by: Gautam Chopra & Rita M. Ryan

What is FIRPTA & When Does it Apply?

The Foreign Investment in Real Property Tax Act (FIRPTA) was enacted in 1980 to establish equity of tax treatment of ownership in U.S. real property between foreign and domestic investors. FIRPTA authorizes the United States to tax foreign persons on their dispositions of U.S. real property interests.

FIRPTA withholding applies when:

  • U.S. real property interests are disposed (as in a sale transaction);
  • The buyer/transferee is a U.S. person; and
  • The seller is a foreign person (non-U.S. citizen, Green Card holder, or U.S. tax resident).

The “foreign person” can be an individual, foreign corporation, foreign partnership, foreign trust, or foreign estate.

Technical Pieces to the FIRPTA Puzzle

What is a U.S. Real Property Interest?

A U.S. real property interest (USRPI) is an interest, other than a creditor, in real property located in the United States. It also includes an interest in a domestic corporation if such corporation held an interest in U.S. real property.

Disposal of stock in a domestic corporation, such as U.S. Real Property Holding Corporation (USPHC) is subject to FIRPTA. USRPHC is a domestic corporation if the fair market value of its USRPI is at least 50% of the sum of:

i. Its total USRPIs;

ii. Its total interest in real property outside the U.S.; and

iii. Any other assets used in trade or business.

Disposition

A disposition for the purposes of FIRPTA includes not only the sale, but disposition by any means, including but not limited to exchange, liquidation, redemption, gift, transfers, etc.

Any disposition of an interest in a partnership, which holds USRPI is also liable to FIRPTA.

Rates of Withholding

The buyer (transferee) is required to deduct and withhold a tax on the total amount realized by the foreign person on the disposition, generally at the rate of 15%.

The amount realized can be different from the actual consideration and includes fair market value of any other property transferred, and the amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.

A distribution to a foreign shareholder by a domestic corporation is also liable to FIRPTA withholding if the shareholder’s interest in the corporation is a USRPI and the property distributed is either in redemption of stock or in liquidation of the corporation.

Exceptions to Withholding

There are several exceptions to withholding under FIRPTA. No FIRPTA withholding is required on disposition of interest in a domestic corporation if any class of stock of the domestic corporation is regularly traded in a securities market. Interests in domestically controlled Real Estate Investment Trusts (REITs) are not considered as USRPIs and therefore, not liable to FIRPTA withholding, though they may be liable to U.S. taxation generally. Qualified foreign pensions funds are also exempt from FIRPTA.  Several other exceptions are quite complex and require valuation and a five-year look back.

Lower Withholding

If the actual tax liability on the sale of USRPI is less than 15%, then the buyer (transferee) can apply for a withholding certificate from the IRS to reduce the amount of actual withholding required. The foreign seller can also obtain a withholding certificate from the IRS stating that a withholding amount lower than 15%, is appropriate in the specific case.  Practically, it may take several months to obtain the lower withholding certificate from the IRS.

Issues to Consider

Navigating the provisions of FIRPTA can be quite complex and gives rise to many issues.  We have prepared the below list relative to the most common issues we face:

  • Determination of Foreign Status in Certain Circumstances:
    • In case of a single-member Limited Liability Companies (LLCs), formed in the U.S., it is important to look at the status of the single member, and not merely the fact that the LLC was incorporated in the U.S. If the transferor is a foreign person and the transferee fails to withhold, the transferee may be held liable for the tax.
    • For cases in which a U.S. business entity, such as a corporation or partnership, disposes of a U.S. real property interest, the business entity itself is the withholding agent.
  • Withholding Rate: Withholding under FIRPTA is imposed on the amount realized, and not the actual gain realized- and therefore, in case of shortfall, the buyer may have to fund the shortfall from other sources.
  • Filing Deadline: The Forms 8288, 8288-A, AND the withholding must be transmitted to the IRS by the 20th day after the date of transfer. The date of transfer has no association with any income tax return filing nor is the FIRPTA filing tied to an income tax return filing.
  • USRPI Stock: Stock held in a domestic corporation, which is determined to be a USRPHC, is considered to be a USRPI for five years thereafter, unless “cleansing rules” are applied. The transferee, therefore, may be required to make this complex determination before applying FIRPTA.
  • It Takes Time: FIRPTA requires advanced planning if a reduced withholding is anticipated, or the amount at closing is anticipated to be insufficient for the withholding. Exceptions from FIRPTA for non-recognition transactions require careful understanding of the exceptions and its application in the given case.

Need Assistance?

The International Tax Services Team at Wolf & Company can help. We specialize in international tax reporting and can guide you on the right path to compliance.