So what the heck is this FIRPTA thing, and why do I keep hearing about it? First things first: FIRPTA stands for the Foreign Investment in Real Property Tax Act of 1980, a federal law requiring the accurate reporting and remittance of U.S. capital gains taxes for foreign investors. Ok great, so what does that mean for real estate transactions here in Florida?
According to the National Association of Realtors (NAR) 2018 Profile of International Transactions in the U.S. Residential Real Estate, 19% of all international residential property purchases in the U.S. occurred in Florida, the highest of all states. Additionally, 61% of the properties sold by international sellers in the U.S. were in Florida, California, Texas, Arizona and New York. As these stats show, Florida sees and will continue to see a significant amount of transactions involving foreign parties.
Prior to FIRPTA’s enactment in 1980, foreign sellers were often exempt from paying income tax on the sale of U.S. real property due to tax loopholes existing at the time. Many times, these loopholes weren’t even available to U.S. citizens. The enactment of FIRPTA, however, changed this and created the requirement for a tax withholding, at the time of the sale, to prevent foreign sellers from skipping town without paying their income taxes or filing the required income tax return. If they fail to do either, the withholding is there to protect the U.S. government.
In general, FIRPTA states that if the seller of U.S. real property is foreign, then 15% of the gross sales price must be withheld at closing and remitted to the IRS within 20 days of the closing, unless an exception applies (more info on that below). This withheld/remitted amount is NOT the actual tax due on the sale, as the tax is not determined at the time of the closing, but rather at a later date. Once the actual tax due is determined, the IRS retains the tax from the withheld/remitted funds, and any remainder is returned to the seller. In most cases, the withheld/remitted amount more than covers the foreign seller’s actual income tax. Simple enough concept. However, identifying and analyzing FIRPTA’s application to any given transaction can be quite complicated.
The first analysis under FIRPTA is to determine if you have a foreign seller. Sellers can come in all shapes and sizes, from individuals, to Trusts, Corporations, LLCs, Estates, etc. These can ALL be foreign sellers, and the analysis for each is different. For example, for LLCs, most people think that if the LLC is a U.S. LLC, that there is no FIRPTA issue. That is not always the case. What if the LLC is a single-member LLC? Unless another IRS entity tax election is made, the single-member LLC would default to being a “disregarded entity,” so you would then look to the individual member, not to the entity itself. If the individual member is foreign, you have a foreign seller (and a FIRPTA issue), despite the LLC being a U.S. entity. For another example, let’s say that an IRS entity tax election is made, such that the LLC has elected to be classified/taxed as a corporation, but one if its shareholders is foreign. Typically, the analysis for corporations is simply whether it was created in the U.S. If so, FIRPTA doesn’t apply. However, while foreign persons can be shareholders of C-corporations, they cannot be shareholders of S-corporations. So what if an error was made in the entity tax election, or what if the seller made a false S-corp election? More documentation will be needed to determine if you have a foreign corporate-seller, e.g. the C-corp election acceptance letter from the IRS.
So you have determined that the seller (individual, corporation, LLC, etc.) is foreign, now what? Well, that depends on if the exception applies. NOTE: this exception only applies to residential property and only applies if the buyer is an individual or individuals. Assuming both, then you can move on to the analysis of whether the exception applies:
- Exception Question 1: Is the property selling for $300,000 or less? If yes, proceed to Question 2, if not, FIRPTA withholding is required (see below for more information on how much).
- Exception Question 2: If the property is selling for $300,000 or less, does the buyer have definite plans to reside and use the property for at least 50% of the time that the property is used by anyone during the first two 12-month periods following the closing?
If both of the above questions are answered “yes,” then the exception applies, and the buyer may sign an affidavit stating these facts, and under these circumstances alone can FIRPTA withholding be legally avoided.
But if the exception does not apply, you have to withhold, and the question then becomes what amount is withheld? The Protecting Americans from Tax Hikes Act of 2015 made determining this even more complicated, believe it or not. This law, effective February 16, 2016, created a tiered analysis for determining the withholding amount. If the sales price is $300,000 or less, but fails to meet the usage requirement of Exception Question 2 above, then the withholding amount is 15%. If the sales price is greater than $300,000, but no greater than $1 million, and the buyer meets the usage requirement of Exception Question 2 above, then the seller would qualify for withholding in the amount of 10%, instead of 15%. However, if the sales price is greater than $1 million, then regardless of the buyer’s intended use, the withholding amount is 15%. Confused yet?
At this point, you’ve determined that you have a foreign seller, the exception doesn’t apply, and you’ve determined the amount of the withholding. So what happens with the withheld funds? Well, that is yet another analysis. If the seller has applied for “reduced withholding” no later than the closing date, then the tax withholding may be escrowed until such time as the reduced withholding amount is determined. That amount is eventually documented by a “withholding certificate” from the IRS to the seller or the seller’s accountant. The withholding certificate will then be given to the escrow agent holding the funds, and the reduced amount provided for in the withholding certificate will be remitted to the IRS and the remainder will go back to the seller. However, if the seller did not timely apply for the reduced withholding before closing, then the full withholding amount is remitted to the IRS no later than 20 days after closing. Confused even more? I’m sure you are!
A relevant aside here regarding liability. A little known fact about FIRPTA is that the liability for the correct handling of all of the foregoing falls on the shoulders of the buyer. The buyer could be subject to severe penalties, late fees and interest if there is a misstep. From the IRS’s standpoint, this makes sense, as unlike the seller who has probably already left the country, the buyer, at a minimum, owns real property here. In such a case, the buyer, and buyer’s property, is the best option for recourse for the IRS. Seems unfair, yes, but that is the law. Therefore, it is absolutely essential that you and your clients work with qualified professionals experienced in the complex FIRPTA withholding procedures. Your best approach is to identify the issue (i.e. that you have a transaction involving a foreign seller/buyer) as soon as possible, and let the attorney/closing agent know right away.
In all types of real estate transactions, especially those involving FIRPTA issues, be sure to contact a Florida licensed real estate attorney to discuss the issues presented here, along with any others that may come up specific to the transaction.
This blog is intended for informational purposes only and it is not intended to be, nor should it be construed as, legal advice or legal opinion. The reader should not consider this information to be an invitation to an attorney/client relationship, should not rely on information presented here for any purpose, and should always seek the legal advice of counsel in the appropriate jurisdiction.