The Foreign Investment in Real Property Tax Act (FIRPTA), enacted in 1980, is a federal law designed to ensure the U.S. government collects taxes on gains realized by foreign individuals or entities when selling U.S. real estate. Prior to FIRPTA, many foreign investors were able to sell U.S. property without paying U.S. taxes, resulting in loss of tax revenue for the government. FIRPTA addresses this issue by requiring buyers to withhold a percentage of the sales price—currently 15%—to cover potential capital gains tax liabilities of foreign sellers.
How FIRPTA Works
When a foreign person sells a U.S. real property interest, the buyer is required by law to withhold 15% of the sale price and remit this amount to the Internal Revenue Service (IRS). This withholding acts as a prepayment of the seller’s U.S. income tax on any gain from the sale. Subsequently, the foreign seller must file a U.S. income tax return (Form 1040NR for individuals or Form 1120-F for foreign corporations) to determine the actual tax owed based on the gain from the sale (sale price minus adjusted basis). If the withholding exceeds the actual tax liability, the IRS refunds the difference.
Who Is Subject to FIRPTA?
FIRPTA applies to all foreign persons and entities—including nonresident aliens, foreign corporations, partnerships, trusts, and estates—that sell U.S. real property interests. This includes sales of residential and commercial real estate, as well as shares in U.S. real property holding corporations under certain conditions.
Key Provisions
- Withholding rate: Generally 15% of the gross sales price, increased from the previous 10% rate.
- Buyer’s responsibility: Mandatory withholding and remittance to the IRS; failure can result in penalties.
- Seller’s obligation: File a U.S. tax return reporting sale and calculating actual gain.
- Withholding as credit: Amount withheld is credited against the actual tax due.
Exceptions and Reductions
There are certain exemptions and reductions available under FIRPTA:
- If the property sells for $300,000 or less and the buyer intends to use it as a residence, withholding is not required.
- Sellers can apply to the IRS for a withholding certificate to reduce or eliminate withholding if they expect their tax liability to be less than 15% of the sale price.
Common Misconceptions and Pitfalls
- Withholding is on sale price, not gains: Buyers must withhold on the full sales price, even if the profit is smaller.
- Failure to file U.S. tax return: Sellers must file a U.S. tax return; withholding is not the final tax calculation.
- Buyers neglect their withholding duty: Buyers can be held liable if they do not withhold taxes.
- FIRPTA only on residential property: FIRPTA applies to all real property interests, residential or commercial.
Practical Tips for Foreign Sellers
- Consult a U.S. tax professional well before selling to properly plan.
- Consider applying for a withholding certificate to potentially reduce withheld amount.
- Keep detailed records of purchase price, improvements, and related expenses to accurately determine gains.
- Understand FIRPTA’s impact on cash flow during sale transactions.
FIRPTA Basics at a Glance
| Topic | Detail |
|---|---|
| Who Must Withhold? | Buyer of U.S. real property from foreign person |
| Withholding Rate | 15% of gross sales price |
| Purpose | Prepayment of capital gains tax owed |
| Seller Filing Requirement | File Form 1040NR or 1120-F to report gain |
| Exceptions | Property ≤ $300,000 used as a residence; IRS withholding certificates |
| Penalties | Buyers face penalties for failure to withhold |
Frequently Asked Questions
Q: Does FIRPTA apply to sales of shares in U.S. real property holding corporations?
Yes. Sales of shares in corporations where U.S. real estate constitutes a significant portion of assets may trigger FIRPTA withholding.
Q: What if the buyer does not know the seller is foreign?
Buyers should request certification of the seller’s foreign status. If the buyer fails to withhold due to willful neglect, they can face IRS penalties.
Q: Can the withholding be refunded if the seller’s actual tax is less?
Yes. After filing a U.S. tax return reporting the sale, the seller can claim a refund for any excess withholding.
Additional Resources
For more information, visit the IRS FIRPTA resource page and see IRS Publication 515, which explains withholding tax on foreign sellers.
By understanding FIRPTA and its requirements, foreign sellers of U.S. real estate can navigate their tax obligations effectively, avoid penalties, and manage withholding amounts to suit their financial planning needs. Effective tax planning may include requesting withholding certificates and consulting U.S. tax professionals prior to sale.