Pat Hune, Broker, 1st Southwest Realty, March 2019
Recently one of my clients decided to sell her rental property. Unfortunately she was not a US Citizen or a Permanent Resident Alien. This triggered the Foreign Investment in Real Property Tax Act (FIRPTA) put into place by the IRS in December 1980. The law says foreign sellers must pay income tax if they sell a US real property asset. (Note: If the property sells for less than $300,000 to an owner/occupant then FIRPTA does not apply. Regardless of the price if the property sells to an investor FIRPTA will apply. But just to make it interesting if the property is held by a US LLC or partnership that has been set up in a certain way then FIRPTA may not apply. How a buyer determines whether FIRPTA does, or does not, apply is the challenge.)
The tax is imposed at regular tax rates for the taxpayer/seller on the amount of gain recognized. Purchasers, aka Buyers, of a foreign person’s real property are required to withhold tax and send it to the IRS. The seller can apply to have the withholding reduced from the typical 15% to an amount that will cover the tax liability. The application has to be made to the IRS in advance of sale. Receiving approval for the reduction from the IRS can take time because it is the IRS. FIRPTA requires the tax to be paid within 20 days after close of escrow unless an application has been made for the reduction. Typically real estate sales are handled by a title and escrow company. They do not like to hold the money even if an application for a reduction has been made.
So what does this mean to a buyer? The IRS law says it is the buye’rs responsibility to determine if FIRPTA applies to the seller, collect the 15% tax and send it to the IRS. If the buyer does not collect the money from eh seller they will be responsible for sending the IRS the 15% tax. And of course there will surely be penalties that I did not take time to research. Ouch! Why is the buyer responsible? The idea is the seller is long gone and the buyer has the US based asset. Therefore the buyer should have done an investigation to determine if FIRPTA applies before completing the purchase of the property. (Note: If the transaction closes through a title and escrow company the title company will send the money and the IRS forms they receive from the buyer to the IRS.)
So how does the buyer determine if FIRPTA applies? Most real estate transactions involve a realtor. The seller’s realtor has a duty to disclose any material facts about the property including FIRPTA. If there is no realtor involved then the buyer can ask the seller. If the seller says FIRPTA does not apply how does the buyer confirm the seller is telling the truth? The title company would be in contact with the seller as they have to send original documents to be notarized. However it is not the title company’s responsibility to say if FIRPTA applies. The buyer can look at the tax records to see the seller’s address. However the seller could be a US Citizen and living in a foreign country temporarily. If the property is held in an LLC it may be difficult to determine who is selling the property.
In this seller’s case there was a Certified Public Accountant (CPA) that confirmed FIRPTA did apply. There were a fistful of IRS forms to be completed. According to FIRPTA it is the buyer’s responsibility to make sure the forms are completed correctly. Everyone was saying the buyer had to get the information directly from the seller. The title company will not assist in figuring out which forms actually do apply or how to fill them out. Again it is the buyer’s responsibility to contact the seller and get the information for the forms including the tax liability and the TIN, (a social security type number), needed for the form. Exactly how the buyer is going to figure out the seller’s tax liability was a mystery.
An impasse had been reached because the seller did not know how to fill out the forms and neither did the buyer. I asked the seller’s CPA to assist because she had been filing the taxes for the seller. Therefore she had all the information, i.e. the tax liability and the seller’s TIN number and whether or not FIRTA applied. I was met with resistance. The CPA, just like title company, said it was the buyer’s responsibility to fill out the forms. It took awhile but I finally beat the IRS forms with the seller’s information out of the CPA. The forms were forwarded to the buyer to complete his portion. This escrow has not closed yet as the seller’s original documents are in transit. I am hopeful all will go well and this will soon just be a fond memory.
How likely is it that a buyer could purchase real estate from a foreigner? The National Association of Realtors reported foreign investment in US Real Estate in 2017 was $78.1 billion for foreigners residing in the US and and $74.9 billion to non-resident foreigners. China was number 1 spending $31.7 billion, followed by Canada ($19B), the United Kingdom ($9.5B), Mexico ($9.3B) and India ($7.8B). About 4% was of the total was spent in Arizona. And this is just in one year!
The moral of the story is if you are buying a property be sure to check to to see if FIRPTA applies. Most foreign investors will have a US based CPA. But if they don’t getting the IRS forms filled out properly could be a challenge. I now know more about FIRPTA than I ever wanted to know. If you think you have a FIRPTA issue please contact me before writing the contract. I will refer you to a CPA and title company that should be able to help you.