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December 22, 2016   |   By: Max Dilendorf, Esq. and Rika Khurdayan, Esq.

1031 Like-Kind Exchanges for Foreign Investors in U.S. Real Estate

There are many reasons why foreign investors look at the United States (and especially large cities like New York) for real estate investment opportunities. A well-developed economy, with liquid and efficient markets, along with a relatively stable real estate market make the United States an excellent place to invest in real estate.

However, foreign investors should be aware of some unique tax requirements governing sale of US real property.

Can a Foreign Investor Participate in 1031 Like-Kind Exchange? If yes, what are the implications?

Like US residents, foreigners can participate in so-called Like-Kind Exchanges under IRC code Section 1031 (“1031-Exchange”) upon sale of US real property interest. However, Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) can significantly complicate a 1031-Exchange process for foreign investors.

It’s a common misconception among foreign real estate investors that they can bypass FIRPTA withholding by participating in a 1031-Exchange.

If the transaction is structured inefficiently, the foreign seller would have to part with a portion of realized sales proceeds to comply with FIRPTA withholding rules. This means that the full sale proceeds may not be available for the purchase of the exchange property.

How Does FIRPTA Work?

Under FIRPTA, the buyer of U.S. real estate from a foreign seller must withhold taxes equal to 15% of the amount realized from any sale over $1M. If a transaction is less than $1M, the withholding is 10%, and on a transaction below $350K for a personal residence, there is no withholding requirement.

For example, if a foreigner sells a property for $1M, the buyer would be obligated to withhold $150K and send it to the IRS (15% of the purchase price).

FIRPTA was instituted to capture capital gain taxes that were not paid by foreign entities. It is sometimes referred to as a 15% tax, which is a misconception because once a foreign entity files the correct tax forms, any amount in excess of the required capital gain tax is refunded.

How to Reduce FIRPTA Withholding in a 1031-Excahnge Transaction?

The good news is that a foreign seller can apply for a FIRPTA withholding certificate with the IRS to reduce the required withholding amount at closing, thus, increasing the amount of cash to fund the purchase of 1031-Exchange replacement property.

It can take the IRS up to 90 days to process the seller’s withholding certificate application, so it is important to plan ahead in a transaction involving foreign-owned property.

Our team recently assisted several foreign real estate sellers in obtaining withholding certificates:

  1. reducing the withholding amount from $462,000 to $183,000 on the sale of a $3.08M investment property in New York City;
  2. reducing the withholding amount from $225,000 to $33,600 on the sale of a $1.5M condominium in Manhattan; and
  3. completely eliminating the withholding of $315,000 on the sale of a $2.1M investment property in Manhattan.

There are many moving parts to a 1031 exchange transaction, especially when a foreign seller is making the exchange. We can help to ensure that a contemplated sale and 1031-Exchange transactions are executed efficiently and in compliance with applicable IRS regulations.

For any questions about structuring sale of property by a foreign investor and/or applying for a FIRPTA withholding certificate with the IRS, please feel free to chat with one of our legal representatives or contact our Manhattan office at 212.457.5757

Tax Disclaimer: The information contained herein is general in nature and based on authorities that are subject to change. We do not guarantee neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. We assume no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations.
Circular 230 Disclosure: This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
This article is provided for your convenience and does not constitute legal advice. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Prior results do not guarantee a similar outcome.

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