How Foreign Investors Can Reduce or Eliminate FIRPTA Withholding Upon Sale of U.S. Real Estate
For foreign investors, FIRPTA can make a relatively simple transaction a much more complicated affair and tie up funds that could otherwise be quickly reinvested. What many New York real estate professionals and investors don’t know is that FIRPTA can, in many cases, be minimized or avoided altogether.
What is FIRPTA?
FIRPTA was instituted by the IRS to ensure capital gains taxes were captured from foreign investors that did not file traditional tax returns. FIRPTA requires the buyer of property owned by a foreigner to withhold a percentage of the total purchase price and surrender it to the IRS.
Foreign seller then must file taxes on the sale of the property for the year in which the sale took place. Since the seller is only responsible to pay applicable tax rate on gains received from the transaction and not the purchase price at which the property was sold, any funds paid above the applicable tax rate are refunded during the relevant tax period. Such setup often results in extra funds paid as part of FIRPTA withholding being tied up for an extended period.
The current withholding percentages are 15% for sales of over $1M and 10% for less, with personal residences under $350,000 being exempt. While FIRPTA ensures that foreign investors are contributing their fair share, it can also cause complications and is generally inconvenient because a large chunk of proceeds from the sale is not available to the seller until a much later date. In some cases, it can prevent timely reinvestment, complicate 1031 exchanges, and can cause financial distress.
How Do I Reduce or Eliminate FIRPTA?
For foreign investors, the IRS has created a process that can reduce or negate FIRPTA withholding. By obtaining a Withholding Certificate, a foreign property owner can reduce FIRPTA withholding at the time of sale.
When assisting foreign clients to apply for a Withholding Certificate, we analyze many factors to determine an optimal solution for reducing the withholding amount, including original purchase price of the property, length of ownership, capital improvements, closing costs and location of the seller’s residency.
Further, when scheduling a closing date for the property, it is important to keep in mind that it takes the IRS approximately 90 days to process an application for a Withholding Certificate. If the application is filed before the sale closes but has not been processed yet, the buyer’s attorney or closing agent can hold the FIRPTA funds in escrow rather than delivering them to the IRS.
Every transaction involving sale of U.S. property owned by a foreign person is time-sensitive, unique and subject to FIRPTA reporting and withholding requirements. It is important for a foreign seller of U.S. property to consult with an experienced tax professional and real estate attorney to ensure that the sale transaction is executed efficiently and with minimum or no FIRPTA withholding.