Selling US property? Get your FIRPTA on
Are you someone with a condominium or other real estate, which you’ve been using as a second home in the United States? Or do you have some investment rental property there? Maybe, a warehouse or other business real estate?
It is time to get your FIRPTA on.
What is FIRPTA?
The Foreign Investment in Real Property Tax Act (FIRPTA) imposes a tax on the sale of U.S. real property by a foreign person. However, because the IRS may have no jurisdiction over a foreign seller, FIRPTA requires that anyone purchasing property from a foreign owner withhold 15 per cent of the purchase price.
Thus, the FIRPTA rules relieve the IRS from having to chase foreign sellers of U.S. property to recover the U.S. taxes owed on that sale.
With certain limited exceptions, FIRPTA applies to almost all cases of every sale of a U.S. real property interest by a foreign seller. The seller can apply any amounts withheld by the buyer as an offset to any tax liabilities arising from the sale. In addition, a foreign seller may receive a foreign tax credit for the U.S. federal income taxes paid in determining the seller’s home country tax.
Without relief, this can cause significant cash flow issues for the seller – particularly if the property was sold for funds to satisfy other debt obligations or to finance a new venture.
For instance, a property sold for $500,000 could result in a $75,000 hold back, and it can take a year or more to get a refund once the return is filed in the subsequent year. The holdback can be even longer if the IRS decides to take a closer look at the transaction, for example, you may need to provide documentary evidence to the IRS for improvements and expenses, such as contractors’ invoices.
Consider a property you bought for $500,000, and you added $100,000 in improvements. Closing costs, lawyer fees, title searches and other expenses totaled $30,000. The resulting sum of $630,000 is what the IRS considers your ‘basis’ in the property.
If the property sold for $830,000, the FIRPTA withholding would be $124,500. However the actual taxes due on that sale would be much lower since the capital gain would be $200,000, due to the improvements made and the expenses incurred. As such, using the top marginal personal tax rate of 23.8 per cent, the actual U.S. federal income taxes owed would be as high as $47,600.
The FIRPTA implication gets even more painful if the property was sold at a loss, and there are no capital gains to be realized. The buyer must still withhold 15 per cent of the purchase price at the time of sale and seller must wait to apply for a refund in the subsequent year.
One way to minimize the tax impact of FIRPTA is to apply to the IRS to reduce the amount withheld to an estimate of the U.S. federal incomes taxes due (which can drop the withholding to zero if the property is sold at a loss). The application process sounds straightforward, and on its surface, it can be. However, there are several potential pitfalls, including the need to obtain a U.S. tax identification number for non-U.S. persons, and the reporting requirements associated with the application.
With respect to all U.S. tax matters, there are some procedures that can be completed by the taxpayer directly, with no major concerns. Other tax matters are better handled by an experienced U.S. tax professional who is familiar with the procedures and documentation needed. If you are considering selling a U.S. real property interest, contact your local U.S. tax advisor for further discussion.