The purpose of the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) is to ensure that foreign investors are paying U.S. federal income tax on the sale or disposition of their U.S. real property interests in a way that is similar to the obligations imposed on U.S. citizens. Before its enactment, it was possible for foreign investors to structure their investments in U.S. real estate in a way that would avoid paying U.S. federal income tax.
If you are a Mexican or Latin American investor planning to buy or sell real property in the United States or invest in a company that owns real property in the U.S., it is important that you fully understand your obligations under FIRPTA. Ignorance of the law is not considered a valid reason for nonresident aliens to fail to pay the necessary tax.
Defining Real Property Under FIRPTA
A U.S. real property interest (USRPI) can include land and structures, as well as a corporation with interest in real property. A U.S. real property holding corporation (USRPHC) is a corporation where the fair market value of its USRPI equals or exceeds 50% of its total assets.
Any USRPI or USRPHC interest, other than as a creditor, triggers a FIRPTA tax obligation.
Withholding FIRPTA Taxes
FIRPTA taxes are initially collected through withholding. This is done to ensure that U.S. tax will be collected while incentivizing foreign persons to file the appropriate tax returns to report their income from the sale and claim a credit for the withheld funds.
FIRPTA withholding obligations are placed on the buyer rather than the seller of the U.S. real property interest. Unless an exemption applies, the buyer must withhold 10% or 15% (depending on whether the value of the property is above or below $1 Million) of the total purchase price if the seller of the property is a foreign person who is not a U.S. citizen or permanent resident.
There are three common FIRPTA exemptions:
- The seller is a U.S. taxpayer, such as a green card holder or a person with a substantial presence in the U.S.
- The price of the real property is under $300,000, and the buyer intends to reside in the property at least 50% of the time during the first 24 months following the closing.
- The 15% withholding tax would exceed the maximum tax liability. (In this case, the seller can apply for a withholding certificate that will reduce the withholding to the amount of tax that is due.)
The buyer withholding FIRPTA taxes is required to file Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests, with the IRS. These forms and payment of the withheld tax must be submitted by the 20th day following the sale. The IRS will then send a copy of Form 8288-A to the seller to be included in their tax return for the year.
Potential Liquidity Concerns Associated With FIRPTA
For many Mexican or Latin American investors, the 10% or 15% withholding tax exceeds their tax liability. If a seller doesn't apply for a withholding certificate to reduce the amount of tax that is withheld, they are eligible for a refund when they file their U.S. tax return. However, processing refunds for foreign persons filing Form 1040NR, U.S. Nonresident Alien Income Tax Return, can take up to 18 months.
If you are a smaller investor who has recently sold a high-dollar property, waiting for a refund of FIRPTA tax overpayment could result in liquidity issues that would negatively affect your other investments. Therefore, it is crucial to apply for the withholding certificate in a timely fashion.
The IRS tries to respond to requests within 90 days. When the withholding certificate can't be issued before closing, the buyer gets to decide if the funds need to be paid within 20 days of the closing or if they are allowed to remain in escrow pending the approval or rejection of the application for the FIRPTA withholding certificate.
Consult an Experienced International Business Attorney
FIRPTA compliance is notoriously complicated. Reporting and payment mistakes are fairly common, often due to simple misunderstandings. For example, foreign persons may believe that their tax obligations have been satisfied through the withholding at the time of sale, and then subsequently fail to file the necessary U.S. tax returns. This can result in penalties that include payment of the tax that should have been withheld, interest, and fines.
To avoid having a problem with the IRS, it is best to consult a business law attorney with experience in issues involving foreign persons investing in the United States. At MEG International Counsel, P.C., our dually licensed international business planning attorneys take the time to understand your goals and recommend tax planning strategies personalized to fit your unique needs. Contact us to learn more.