At the November meeting of the Lancaster Commercial and Industrial Real Estate Council, Rich Weeber of Regal Abstract warned of the problems that the “Foreign Investment in Real Property Tax Act” or FIRPTA could cause in real estate transactions. In a room full of real estate professionals, we discovered that some people had no idea what FIRPTA was, and the rest of us only worked through it when we had to. It didn’t seem like anyone felt 100% comfortable with what to do if it came up.
This post will explain what FIRPTA is, what to do if it applies in a real estate transaction, and the dangers of not paying attention to it.
What is FIRPTA?
Congress enacted FIRPTA in 1980 to manage foreign investment in U. S. real estate. (I remembered it as a reaction to Japanese investors buying American property, such as Pebble Beach Golf Course, Rockefeller Center and lots of other Manhattan properties in the 1980’s, but it turns out the law was passed before those things happened.) The goal of FIRPTA is to capture income when a “Foreign Person” sells “U. S. Real Estate.”
There are a lot of tax provisions inside of FIRPTA, but the one that matters in real estate transactions is that when a Foreign Person disposes of U. S. Real Estate, the Buyer needs to withhold 15% of the sales price until the FIRPTA taxes are settled.
What does FIRPTA Apply to?
There are a couple of key definitions in FIRPTA. They are:
When the Seller of Property is a
- non-resident alien individual (that means, generally, someone without a green card)
- foreign corporation (that has elected to be treated as a domestic corporation)
- foreign partnership
- foreign trust, or
- foreign estate.
If U. S. real estate is owned in part by a Foreign Person and in part by a non-Foreign Person, then FIRPTA applies. In general, if any part of the ownership of the property is with a Foreign Person, then FIRPTA applies. This includes if a trust sells the property and one of the grantors is a Foreign Person and situations where a Foreign Person assigns their right to purchase a property to a U. S. corporation.
This includes most transfers of real property. It includes sales, exchanges, gifts, transfers, redemptions, etc.
U. S. Real Property Interest (USRPI)
This is an ownership interest in U. S. real property. But it can also include ownership of a U. S. company if the U. S. company owns any U. S. real estate.
Note that changes in FIRPTA made in 2015 apply to Real Estate Investment Trusts and Regulated Investment Companies, with respect to their status as USRPI. Those are way outside the scope of this blog article.
Exceptions to FIRPTA
There are a handful of situations where FIRPTA does not apply. That means that the Buyer of the property does not need to withhold 15% of the purchase price. Two of them come up regularly:
- FIRPTA does not apply when a Buyer purchases U. S. Real Estate (i) for use as the Buyer’s residence and (ii) so long as the purchase price is not more than $300,000.
- FIRPTA does not apply if the Seller gives a certification stating – under the penalty of perjury – that the Seller is not a Foreign Person. The certification needs to give the Seller’s name, Tax Identification Number and address.
Note that this Certification is not effective if the Buyer or the Settlement Agent (called a “Qualified Substitute”) know that the Certification is false.
The Seller can also get a “withholding certificate” from IRS that says the Buyer does not need to withhold any of the sales price.
What Happens at Settlement?
If the Seller is a Foreign Person, and no exceptions apply, the Buyer needs to withhold 15% of the sales price. The Buyers eventually need to report and pay the tax due to the IRS.
What are the Penalties for Not Following FIRPTA?
FIRPTA requires the Buyer to withhold taxes from the transaction. If the Buyer does not withhold taxes, the Buyer can be liable for the taxes, including interest and penalties. Although Weeber said that the taxes are a personal liability (i.e., not a title defect on the newly purchased property), I am not sure that this is true. As a tax lien, if the Buyer fails to withhold FIRPTA taxes, the liability could take priority over the liens of mortgage on the property.
In addition to the Buyer being liable for FIRPTA taxes, the Seller’s agent, Buyer’s agent and Settlement agent can also be liable for the taxes. These people can be liable for the FIRPTA taxes if they get a FIRPTA certificate of non-Foreign Person status that they know is false.
What Do We Do?
This seems like a daunting task. But it does start out simply. People involved in a real estate transaction need to:
- Know who the Sellers are. Before the parties get to the settlement table, the Agreement of Sale should have a section that represents whether the Sellers are or are not Foreign Persons.
- If the Seller is an entity (corporation, LLC, trust, etc.), look behind the entity. If a Seller is an LLC, but one of the members is a Foreign Person, then FIRPTA will apply. That is, unless the LLC has opted to be taxed as a domestic S Corporation. The point is to do your homework if there is any doubt.
- Know if one of the exceptions applies. For commercial real estate, this usually means getting the FIRPTA affidavit from the Sellers. As always, include all of your important contract provisions in your agreement of sale.
- Get the IRS certifications. Remember, the Buyer does not have to withhold FIRPTA taxes if it receives a FIRPTA certification of non-Foreign Person status.
- If required to withhold FIRPTA taxes, get an expert to file the appropriate forms with the IRS. The 15% is only a withholding. It may or may not be the actual amount of taxes due from the Seller. You will need an accountant somewhere in the process to figure out how much is owed and to file the correct forms.
FIRPTA can be a complication to some real estate transactions, but it does not have to be a deal-killer. If the parties – and their agents – understand what FIRPTA is and what it requires, they can make sure all the issues are taken care of. Like lots of these issues, the key is to identify and manage them early in the transaction and not at the settlement table.