Non-U.S. individuals and corporations investing in real estate within the United States will need to be familiar with one of the biggest challenges facing foreign nationals involved in U.S. real estate: the Foreign Investment in Real Property Tax Act (FIRPTA).
FIRPTA makes sure that foreign nationals earning money off real estate transactions based in America pay their fair share of taxes for it. Under FIRPTA, a foreign seller of U.S. real property is subject to a tax withholding at closing, and the buyer in such transaction is obligated to submit the tax withholding to the IRS. Withholding on a real estate transaction is required only if the seller is a non-U.S. person. In such cases, the seller can avoid having tax withheld by providing a certification of non-foreign status to the buyer.
In general, the IRS imposes an income tax on any given individual’s or entity’s net taxable income. This income tax is mandatory and generally paid by all U.S. persons. In the late 1970s, a large number of foreign investments took place in the U.S. By way of loopholes in tax laws at that time, foreign investors were able to avoid paying income tax on the gain earned on the sale of their U.S. real property, while U.S. persons still had to pay the income tax on their gains.
To balance the scale between foreign and U.S. real estate investors, on December 5, 1980, President Jimmy Carter signed the Omnibus Reconciliation Act of 1980, which included the Foreign Investment in Real Property Tax Act of 1980. After FIRPTA was passed, a foreign individual or entity had to pay income tax on any gain from the sale or exchange of U.S. real property as if such gain was effectively connected to a U.S. trade or business during a given taxable year. This meant that foreign investors could no longer avoid the payment of income tax.
The rate of the FIRPTA tax withholding was increased in February 2016. Prior to February 2016, a buyer who purchased real property from a foreign person was required to withhold from the seller’s proceeds the amount equal to 10 percent of the sales price, subject to certain exceptions.
On December 18, 2015, President Barack Obama signed into law the Protecting America from Tax Hikes (PATH) Act, which became effective on February 16, 2016. The Path Act was responsible for the increase and, today, a foreign seller of U.S. real property is subject to a tax withholding equal to 15 percent of the sales price. The PATH Act also amended the residential exceptions criteria, thereby, maintaining the withholding rate at 10 percent for qualifying transactions. If the seller is a foreign person and the buyer fails to withhold, the buyer may be held liable for the tax.
With a Certification of Non-Foreign Status, the seller of real estate is certifying under penalty of perjury, that the seller is not foreign. Therefore, the seller and the transaction will not have the withholding requirements. The seller provides the U.S. purchaser a certification stating, under penalties of perjury, that the transferor is not a foreign person and containing the transferor’s name, U.S. taxpayer identification number (TIN), and home address (or office address, in the case of an entity).
To be legally valid, certificates of non-foreign status must be signed by the seller and notarized. The Certification of Non-Foreign Status is not valid if the withholding agent has actual knowledge, or receives notice from an agent, that the certifications are false. If the withholding agent is required by regulations to furnish a copy of the certification to the IRS and fails to do so in the time and manner prescribed, the certification may not be effective.
The importance of the Certification of Non-Foreign Status importance can be vital to real estate investment as it plays into the calculation of available funds. For example, if a foreign investor closes a sale of real property for $500,000 subject to FIRPTA withholding tax, ten percent of that price would be withheld and unavailable to the investor even if entitled to a refund, until filing this year’s taxes next year.
As cash flow is a major concern in real estate investment, this may put foreign investors at a disadvantage when selling property early in the year. There are several other exceptions set forth in the IRS guidelines subject to various conditions.
Foreign sellers and the real estate agents for foreign sellers need to be informed and prepared for FIRPTA prior to listing the real property for sale. In addition, buyers need to be aware of FIRPTA if the seller is a foreign person.
It is advisable that a foreign person seeks out both legal counsel and other important tax planning professionals prior to the listing real property to ensure they will be FIRPTA compliant and in the most advantageous position when executing the sale.
I. R.C. § 1445(a); 26 C.F.R. §1.1445-1(b)(1). See, I. R. C. § 7701(a)(30) (defining a “United States Person” as “a citizen or resident of the United States, a domestic partnership, a domestic corporation, any estate (other than a foreign estate, within the meaning of paragraph (31)), and any trust if—a court within the United States is able to exercise primary supervision over the administration of the trust, and one or more United States persons have the authority to control all substantial decisions of the trust”).  I. R.C. §63. William D. Metzger, Foreign Investors Real Property Tax Act: Historical Perspective and Critical Evaluation, 5 W. New Eng. L. Rev. 161, 162 (1982).  Lisa B. Petkun, The Foreign Investors Real Property Act of 1980, 1 Penn. St. Int’l L. Rev. 11, 11 (1982).  Omnibus Reconciliation Act of 1980 (Foreign Investment in Real Property Tax Act of 1980), Pub. L. No. 96-499, §94 Stat. 2682 (1980) (codified as I.R.C. §897).  I.R.C. §897(a)(1). See Protecting America from Tax Hikes Act (PATH Act) of 2015, Pub. L. No. 114-113, §324 (2015) (amending I.R.C. §1445). I.R.C. §1445(a) (2015). See Protecting America from Tax Hikes Act (PATH Act) of 2015, Pub. L. No. 114-113, §324 (2015) (amending I.R.C. §1445). Id. Id. Id.  I.R.C. §1445(b)(2). Id. Id.  I.R.C. §1445(b)(2). Id. I.R.C. §1445(b)(7).
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