By: Merideth Nagel, Esq.
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What is FIRPTA?
Today, we’re going to talk about something that’s super exciting – the Foreign Investment in Real Property Tax Act, also known as “FIRPTA”. This is a subject that many, many of our realtors ask us about and we hope that by sharing this information, we can help dispel some of the confusion surrounding the requirements and regulations.
Let’s just jump right into it!
FIRPTA is the tax regulation that requires special tax withholding when a foreign person sells property in the United States. The first question that’s always asked is, “who qualifies as a foreign person?” The answer to that is pretty simple. You are considered foreign by FIRPTA regulations if:
1. You are not a U. S. Citizen.
2. You DON’T have a green card.
3. And you DON’T pass the “substantial presence test”
Again, it doesn’t matter if you have a tax I.D. number, it doesn’t matter if you have a visa, it doesn’t matter if you have filed tax returns before. If you don’t have a green card and don’t pass the substantial presence test, you are considered a foreign person.
Now, the analyses about whether or not a person satisfies the substantial presence test really needs to be done by their CPA. That person will be very familiar with their financial transactions in the United States. It is not a determination that should be made by the person or their realtor. If they don’t have a green card and they want to try and qualify based on the substantial presence test, they should start working with a CPA right away.
The next question is obviously, “so what happens after you determine someone is a foreign seller?” FIRPTA was designed to punish the buyer of a property if taxes are not properly paid by the foreign seller. Now, that is a little bit counter intuitive because one would expect that because the seller has to pay any taxes due on their sale, the IRS would be targeting the seller. So why has the IRS turned the tables on the buyer?
Consider, for instance, that a person in Belgium buys and sells property in the United States and they don’t pay the taxes that are due. The IRS has no way to chase them – they’re not going to go to Belgium and try to collect the taxes due. So, instead, they impose that tax on the buyer, put a lien on the buyer’s property, and foreclose to pay off that lien if it is not then paid in full. It’s a very serious penalty that buyers sometimes have no idea they could be facing. That’s why it’s so important for realtors and lenders to understand that if the required FIRPTA withholding is not done correctly, the buyer will pay the penalty.
To meet that obligation, what the IRS has done is told buyers that if they buy a property from a foreign person, it is their obligation to make sure the proper percentage of that contract price is collected and remitted to the internal revenue service. The question is, then, “how much is owed?” Generally speaking, 15% of the purchase price is owed at closing and then it’s the buyer’s responsibility to remit that to the IRS. As long as the buyer collects that 15%, they are not responsible if, for some reason, less or more money is owed. It then becomes the seller’s responsibility to work with the IRS in that instance.
Another thing that we are often asked is, “are there any exceptions to FIRPTA?” Absolutely. First and foremost, an obvious answer is that this regulation doesn’t apply to you if you aren’t foreign. However, for those sellers who are foreign, there is a general exception to FIRPTA if:
1. The sale price is $300,000 or less
AND (not or)
2. The buyer, or a member of their immediate family, will reside in the property for at least half the time is is resided in during the 24 months following the sale.
At first glance, many realtors and their buyers think, wow, that’s easy! The sale price is less than $300,000 and the buyer, at the time of the sale, has every intention to make that house their forever home. They’ll sign the paperwork required for that agreement and never withhold or remit payment to the IRS. There is a catch, though. Let’s say that your buyer has every intention of staying in that property for the next two years but, six months in, the buyers wife is pregnant and they decide they need a larger home to accommodate their child or the buyer has to relocate for work. Whatever the case, there is suddenly a life circumstance that requires them to sell their property and buy a new home. The problem is that, if that file is audited (and you can never know if it will be until it happens), it will now be the buyer’s burden to prove to the IRS that their decision to move could not have possibly been anticipated prior to purchase.
It seems really easy, in theory, to just hand them proof of a promotion or proof of the pregnancy and assume that will solve the issue. The problem is that you are dealing with a government agency, which means time, expense, stress, and a process that is unlikely to be ‘simple’ or ‘quick’. If there is any reasonable doubt on their part that the buyer didn’t know these events would happen, they will be penalized. For that reason, we see more and more buyers unwilling to take advantage of this exception. They’re getting smart and realizing that if life changes, they might have to fight the IRS or face dire consequences.
There are, however, some other options available if the buyer on a property refuses to take advantage of that exception. For instance, if you are a listing agent on a property and the seller is identified as a foreign individual likely to have 15% of the purchase price withheld, the first thing you should do is have your seller engage with a CPA. What they can do is help your seller get what is called a “withholding certificate”. This document has to be obtained and presented to the closing agent prior to closing and will come directly from the IRS. Generally, this states either that withholding is not required or that a much lesser amount must be withheld. Both of these options are a much better alternative to losing 15% of the purchase price because at the end of the day, the IRS is going to get their money first. If there is not enough equity in the home to cover the 15% withholding and cover all the closing fees, the seller will have to bring money to the table. Dealing with a CPA that is familiar with FIRPTA practices as soon as a house is listed can save time and money in the end.
If there is no exception available, then the withholding must be done and done by the buyer so it is a good idea to also have your buyer work with a CPA. Not only can the IRS penalize a buyer for not remitting 15% or remitting the wrong amount, they can also penalize them for something as simple as an error on their paperwork when it is submitted. For instance, we know of a case where the buyer did everything right: they withheld the correct amount of money, remitted it to the IRS on time, and did everything they knew that they were supposed to do. In fact, when the seller filed taxes, they actually got some of that money back so it was clear that monetarily speaking, everything was correct. However, on their forms, two numbers in the seller’s tax ID number were flipped. This resulted in a $10,000 dollar fine that was placed on the buyer’s property in the form of a lien. That’s all it took!
We can’t impress upon you enough: rely on your industry professionals! If you don’t a CPA that is familiar with FIRPTA, we can recommend someone to you.
If you have any other questions about FIRPTA regulations or anything at all, please don’t hesitate to reach out to us at the office. Our number is (352) 241-8629.