The Buyer's Burden: FIRPTA Tax Withholding Requirements

In life, two things are inevitable, death and taxes. Unfortunately for the IRS, this axiom did not always hold true for foreign sellers of real property. When foreign sellers of real estate located in the United States owed taxes on gains from a sale, the IRS could not collect unless the seller filed a tax return. Very often, the taxes went unpaid. In an effort to correct this problem, Congress amended 26 USC § 1445 in 1984, placing the duty on the buyer to collect the tax by withholding funds from the sale. The Foreign Investment in Real Property Transfer Act (FIRPTA) requires any buyer of a U.S. real property interest to withhold ten percent of the amount realized by a foreign seller. 26 USC § 1445(a).

Please be aware that ATG does not determine the citizenship of sellers or withhold sellers' proceeds under FIRPTA when conducting closings. This is the buyer's responsibility, not the closer's.

FIRPTA applies to all foreign persons, foreign corporations, and foreign partnerships, selling or transferring property located within the United States. FIRPTA does not consider resident aliens to be foreign persons. Resident aliens possess a green card issued by the Immigration and Nationalization Service (INS) or can prove a legal physical presence in the U.S. for a three-year period.

Because most real property sales do not involve these foreign entities, the majority of transactions involving real property will not require the buyer to withhold funds. However, any real property transaction potentially exposes buyers and the attorneys for both parties to tax liability.

Exemptions

The requirement that a buyer withhold a portion of the sales proceeds applies to every real estate transaction unless it meets one of the following exceptions set forth in Section 1445(b):

The seller furnishes an affidavit stating, under penalty of perjury, that the seller is not a foreign person and provides the seller's U.S. taxpayer identification number, usually a social security number;
The transfer is of an interest in a non-publicly traded domestic corporation where the corporation provides an affidavit stating that the corporation is not and has not been a U.S. real property holding corporation or, as of the date of the transfer, the interests in the domestic corporation are not U.S. real property interests;
The buyer receives a qualifying statement, issued by the Secretary of the Treasury, stating that the foreign seller arranged to pay the tax or is exempt from the tax imposed;

The buyer acquires the property for use as a personal residence and the sales price does not exceed $300,000; or

The first two exemptions do not apply if the buyer has actual knowledge that the affidavit is false or an agent of the buyer discloses to the buyer that the affidavit is false. 26 USC § 1445 (b)(7)(A). If the Secretary of the Treasury requires a copy of the affidavit and the buyer fails to furnish one then the withholding exemption does not apply. 26 USC § 1445 (b)(7)(B).

A corporation meets the definition of a U.S. real property holding corporation if the fair market value of its U.S. real property interests equals half of the total value of all its real property interest worldwide plus all other assets. If at any time during the five-year period before the sale a corporation meets this definition, then the corporation qualifies as a holding corporation.

Withholding

In most cases, the purchaser of a U.S. real property interest must deduct and withhold ten percent of the amount realized by the foreign seller. However, the amount withheld should not exceed the seller's maximum tax liability. 26 USC § 1445(c)(1)(A). To avoid unnecessary withholding, the IRS can determine seller's maximum tax liability in advance.

Obtaining a withholding certificate may reduce or eliminate the amount of withholding required. Either the seller or buyer may apply for a withholding certificate issued by the IRS. 26 CFR 1.1445-3(a). A withholding certificate obtained before the sale may allow the buyer to withhold a reduced amount or excuse withholding entirely. While waiting for a decision on a pending application, the buyer still must withhold ten percent of the sales price. However, the pending application suspends the obligation to pay the amount withheld until the 20th day following the IRS determination. If the amount withheld exceeds the amount specified in the certificate then the seller may apply for an early refund. 26 CFR 1.1445-6(a).

Penalties for Failure to Comply

Section 1461 makes every person required to deduct and withhold tax liable for that tax. 26 CFR 1.1145-1(e)(1). If the buyer fails to withhold the required tax from the seller, then the IRS will collect the tax from the buyer. 26 CFR 1.1445-1(e)(2). A buyer that fails to deduct and withhold tax will also be liable for the interest between the last date when the tax was due and the date when the buyer finally pays the tax. 26 CFR 1.1445-1(e)(2)(ii).

If a buyer fails to withhold and the seller subsequently files an income tax return and pays any tax due then the buyer is no longer liable for the tax. 26 CFR 1.1445-1(e)(3)(i). The buyer will still be liable for the interest if the seller files the return late and does not pay any accrued interest. 26 CFR 1.1445-1(e)(3)(ii). If the IRS issues a withholding certificate establishing that the seller does not owe any tax, then the tax will not be collected from the buyer and no penalty will be imposed for failure to pay the tax. 26 CFR 1.1445-1(e)(3)(B).

Privacy Concerns in FIRPTA Reporting

Some sellers are uncomfortable giving their social security number or other taxpayer identification number to the buyer in their real estate transaction. While these are legitimate and understandable concerns, the IRS has not provided for an alternate procedure to use in reporting FIRPTA transactions. Therefore, some sellers are requiring buyers and their agents to sign a nondisclosure agreement in which the buyer and his or her agent agree to keep the seller's social security number or other taxpayer identification number confidential.

Beyond that, sellers may want to consider the following aspects of FIRPTA reporting and the extent to which they may be used to reduce the need to give the buyer a social security number or other taxpayer identification number, or reduce the risk of doing so:

Forms 8288 and 8228–A are required to include the identifying numbers of both the transferor and the transferee. If any identifying number as required by such forms is not provided, the transferee must still report and pay over any tax withheld on Form 8288, although the transferor cannot obtain a credit or refund of tax on the basis of a Form 8288–A that does not include the transferor's identifying number (see paragraph (f)(2) of this section). 26 C.F.R. § 1.1445–1(c). Therefore, the buyer will also supply his or her identifying number to the seller, and the seller will not be able to receive a refund from the IRS without the identifying number.
A “foreign person” does not include a resident alien. Per the Code of Federal Regulations, "in general, a foreign person is a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, or foreign estate, but not a resident alien individual. In this regard, see § 1.897–1(k). 26 C.F.R. § 1.1445–2. Unfortunately, §1.897-1(k) states: “[Reserved].” However, sellers may want to consider using this section as a basis for giving a FIRPTA affidavit to the buyer and qualifying for the exemption from withholding.
There is one other exemption that may be available to the parties. Under Reg. §1.1445-2(d)(2), a transferee will not be required to withhold if the transferor provides the transferee with a notice setting forth the following information (there is no official form for this, but the transferor’s notice must use the following paragraph labels):
(A) A statement that the document submitted constitutes a notice of a non-recognition transaction or a treaty provision pursuant to the requirements of §1.1445–2(d)(2); (B) The name, identifying number, and home address (in the case of an individual) or office address (in the case of an entity) of the transferor submitting the notice; (C) A statement that the transferor is not required to recognize any gain or loss with respect to the transfer; (D) A brief description of the transfer; and (E) A brief summary of the law and facts supporting the claim that recognition of gain or loss is not required with respect to the transfer. The notice must be verified as true and signed under penalties of perjury by the transferor. The transferee must, by the 20th day after the transfer, send the transferor’s notice, along with a cover letter by the transferee containing the transferee’s name, identifying number, and home address, to the Director, Philadelphia Service Center, P.O. Box 21086, Drop Point 8731, FIRPTA Unit, Philadelphia, PA 19114–0586. This exemption is not available if the transferor qualifies for non-recognition of gain on part, but not all, of the gain realized on the transfer, the transferee knows or has reason to know that the transferor is not entitled to non-recognition of gain, the provisions of Section 121 apply to the transfer, the transfer is a simultaneous exchange under Section 1031 that does not qualify for non-recognition of gain in its entirety, or is a non-simultaneous exchange under Section 1031 in which the exchange has not been completed by the time the transferee must report the transfer to the IRS and pay the withholding.
Finally, the transferor or transferee, any time prior to the closing, may apply to the IRS for a withholding certificate under Reg. §1.1445-3. The withholding certificate may limit the amount to be withheld or excuse withholding entirely. Reg. §1.1445-2(b)(7). Additionally, no withholding is required if the amount realized on the transfer is zero. Reg. §1.1445-2(d)(8).

Agents/Attorneys

Attorneys for both buyers and sellers can find themselves liable. FIRPTA defines agent as "any person who represents the transferor or transferee in any negotiation relating to the transaction or in settling the transaction." 26 USC § 1445(d)(3)-(4). Both the buyer's and seller's agents are required to provide notice to the buyer if they know that the seller's affidavit is false. Any agent that fails to provide notice will be liable for the tax that the buyer should have withheld. However, the agent's liability cannot exceed the amount of compensation the agent earned from participating in the transaction. 26 CFR 1.1445-1(d)(2)(B). An agent that aids in the preparation of or fails to disclose knowledge of a false certification may be liable for civil and criminal penalties. 26 CFR 1.1445-4(e).

Forms

The Treasury Department regulations provide sample certifications used to obtain an exemption from withholding. The certification must state that the buyer is not a nonresident alien for the purposes of U.S. income taxation, provide the U.S taxpayer identification number and address, and affirm that the certification is made under the penalty of perjury. 26 USC § 1445(b)(2). The buyer should retain the certification for five years. 26 CFR 1.1445-2(a)(2)(B).

The buyer must report and pay any tax withheld by the 20th day after the transfer. 26 CFR 1.1445-1(c). The buyer must file IRS forms 8288 and 8288-A, and any 8288-B with the IRS, timely mailing of the forms will be treated as their timely filing. Id. The IRS will provide the buyer with a stamped copy of 8288-A. The seller should attach the form to his tax return and any tax withheld will be credited against any tax due. The seller may use IRS form 8288-B to obtain a determination of the amount to be withheld or a determination that no withholding is needed, ahead of closing. See IRS Form Instructions for forms 8288, for more.

Conclusion

Purchasers of real property and the attorneys for buyers and sellers need to be wary of the possible tax consequences FIRPTA creates. It is critical to determine the citizenship of the seller to avoid liability for taxes, interest, and penalties, and to remember that the buyer must comply with FIRPTA, not the closer. Most real estate transactions will not require the buyer to withhold funds because the seller will be a U.S. citizen. The foreign status of the seller makes no difference for tax withholding purposes if the property will be a residence for the buyer purchased for $300,000 or less. However, merely assuming FIRPTA does not apply to a transaction can expose the buyer or the attorneys to easily avoidable consequences.

EDITOR'S NOTE: ATG has two form affidavits available for members' use when needed: Foreign Transferor Affidavit-Individual; and Foreign Transferor Affidavit-Entity. For our complete Underwriting Guidelines for foreign persons, for use in Illinois, Indiana and Wisconsin, see our Underwriting Manual chapter on Foreign Persons.