Bar News - May 18, 2016
Real Property Law: FIRPTA Withholding Rate Changes Took Effect in February
By: Timothy A. Boucher
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), in place since 1980, requires the buyer of real estate to withhold money from a foreign seller of real estate. There have always been exemptions in place, which make actual withholding a somewhat rare occurrence for the average practitioner.
FIRPTA underwent changes in 2015 when President Barack Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The PATH Act makes many changes to FIRPTA, including increases in the amount foreign investors may hold in a publicly traded US real estate investment trustís (REIT) stock before triggering FIRPTA on the sale of stock or receipt of proceeds from the REITís sale of assets. Though these changes may be significant in spurring foreign investment in commercial real estate, this article focuses on the most common withholding issues faced by practitioners.
Hereís the rule: The buyer is obligated to withhold a percentage of the ďAmount RealizedĒ from the sale of US real estate when the seller is a foreign person. According to the rule, a foreign person is a nonresident alien individual, a foreign corporation that has not made an election under section 897(i) of the Internal Revenue Code to be treated as a domestic corporation, a foreign partnership, a foreign trust, or a foreign estate. It does not include a resident alien individual.
The Amount Realized by the seller is the sum of: 1) cash paid, or to be paid (principal only), 2) the fair market value of other property transferred, or to be transferred, and 3) the amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer. The amount is generally based on the sale price of the property.
Before Feb. 17, 2016, the amount of money withheld from a foreign seller was 10 percent of the amount realized, unless the transaction was exempt or otherwise determined by previous arrangement made with the Internal Revenue Service (IRS). Effective Feb. 17, 2016, the rate changed for some transactions. Subject to the exemptions, below the new rate is 15 percent of the amount realized.
The most common exemption faced by residential practitioners is when the buyer intends to occupy the property being purchased as his/her residence. In such situations, the withholding requirements change, and the rate of withholding can also change.
If the sale price of the property is less than $300,000, and the buyer (or a family member) intends to occupy the property as their residence, no withholding is required. If the sale price of the property is equal to or greater than $300,000, but not more than $1 million, and the buyer (or a family member) intends to occupy the property as their residence, the withholding is 10 percent of the amount realized. If the sale price of the property is greater than $1 million and the buyer (or a family member) intends to occupy the property as their residence, the withholding is 15 percent of the amount realized. In all cases where the property will be used as a residence by the buyer (or a family member), the buyer should sign an affidavit certifying the residency requirements, and this document should be retained.
When the buyer (or family member) does not intend to occupy the property as his/her residence, the withholding rate is 15 percent of the amount realized.
From personal experience, I can tell you it is not a simple process or without stress when withholding is required. It is prudent to investigate the citizenship status of a seller early in the closing process to avoid last-minute disruptions. Many practitioners send sellers a questionnaire requesting information for items such as mortgages and other liens. If it is not already being done, I recommend adding a question relating to citizenship to any questionnaire, so everyone can be put on notice early of the requirements.
In most situations, the seller will sign, under oath, a certificate of non-foreign status confirming they are not a foreign person or entity. Usually this form is provided as part of real estate conveyancing software, and the rule does not contain any specific form. The rule provides for an exception to the withholding requirement when the transferor gives you a certification stating, under penalties of perjury, that the transferor is not a foreign person and containing the transferorís name, US taxpayer identification number, and home address (or office address, in the case of an entity). The buyer may generally rely on this affidavit to protect him or her from liability under the PATH Act for failure to withhold a portion of the sellerís proceeds.
Another useful tool when addressing withholding is the use of withholding certificates. The IRS will issue withholding certificates in some circumstances, which can remove the burden of withholding from the buyer. The certificates are commonly used when the ultimate tax liability is expected to be zero. The seller can file an IRS Form 8288-B to make this request, and the IRS usually takes about 90 days to respond.
Timothy A. Boucher is New Hampshire Senior Underwriting Counsel at First American Title Insurance Company in Concord. This article was originally published in the First American Title Insurance Company newsletter and was republished with permission.