No Fear in FIRPTA When you Know the Rules

With the continued international investment in our area and many international investors looking to take advantage of our real estate market and cash in on their investments, we have seen an increase in the number of transactions impacted by “FIRPTA.” As you would imagine, having the IRS involved in your settlement can complicate matters and lead to hefty penalties and fines if you’re not following proper procedures.

What is FIRPTA? When does it apply?

For a real estate contract, we are only concerned with a small portion of FIRPTA, specifically related to the withholding of funds at the closing, to ensure the seller pays any taxes due to the sale of the property. More specifically, if the seller of U.S. real property is a “foreign person” as defined by the IRS, the buyer must withhold up to 15% of the funds due to the seller at closing. These funds are remitted to IRS or held in escrow until the appropriate paperwork from the IRS is received. This rule would apply to anyone who:

  1. Is not a U.S. citizen or permanent resident; or
  2. The person does not meet the “substantial presence test.”

Are there exceptions to FIRPTA?

As with every rule, there are some exceptions to the withholding requirement. For example:

  1. If the sales price is under $300,000 and the buyer can sign an affidavit to confirm they (or their family) will personally use the property for at least 50% of the time the property is in use, no withholding will be required.
  2. If the buyer signs the affidavit and the sales price exceeds $300,000, the amount withheld can be 10%.

Remember that the buyer is not contractually obligated to sign the affidavit. In this case, modify the contract to reflect if your seller relies on the buyer signing an affidavit or receiving most of their funds at closing. Additionally, ensure the sellers work with a buyer who is able and willing to sign the document.

What happens during a transaction?

Once you know the transaction is not exempt, one of two things has to happen at closing:

  1. Send the 15% (or reduced 10%) to the IRS within 20 days of closing with Form 8288, and then the seller can file a tax return to show their profit/loss. The IRS can then return any excess funds held from the sale to the seller.
  2. Hold the funds in escrow pending receipt from the IRS of a “reduced withholding certificate.” To obtain that document, the seller will need to work with their CPA to submit documents to the IRS in advance of closing, breaking down costs and expenses, allowing the IRS to review and confirm, without a filed tax return, what amount, if any is due from the seller. Release of escrow funds can go to the IRS, the seller, or a combination of the two once the seller obtains the reduced withholding certificate from the IRS per that letter.

The contract gives the buyer the option to determine if they are willing to have funds held in escrow or if they will remit funds to the IRS at closing. The parties need to consider the impact of their decision. At the time of this blog, reduced withholding certificate processing times are much longer than previously. Many CPAs and sellers find that remitting the funds to the IRS immediately, followed by filing a tax return, is a more efficient process in terms of time and cost.

How can you best prepare for a FIRPTA transaction? 

  1. Ensure all parties understand upfront what their obligations areas outlined in Section 18 V. of the FR/BAR contracts;
  2. Ensure engaging someone to prepare the appropriate FIRPTA documentation for closing; and
  3. Ensure that the parties are working with a closing agent familiar with the process who can guide them to the finish line.

FIRPTA can be very complicated. Therefore, the failure to comply with its requirements can create significant liability for the buyers. In addition, the oversight of the seller to anticipate the added cost and expenses of FIRPTA can derail your closing. Finally, if you have any questions about the preceding or questions about transactions involving foreign sellers, we urge you to consult with your local real estate attorney.

Sincerely,

Natasha Selvaraj, Esq. nselvaraj@berlinpatten.com

Natasha is a Partner at Berlin Patten Ebling and primarily practices in the area of residential and commercial rea property transactions.  

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