Foreign investment in U.S. real estate has become more and more prevalent in recent years. However, there are crucial tax considerations for foreign investors when buying and selling U.S. property that need to be kept in mind. The main tax law governing foreign investment in U.S. real estate is the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA). Under FIRPTA, foreign persons are subject to U.S. income tax on dispositions of U.S. real property interests (USRPIs), and FIRPTA imposes withholding tax obligations on the buyer in real estate transactions involving foreign sellers. In this article, we will dive deeper into the key provisions of FIRPTA, including who is considered a foreign person, when tax is triggered, how much tax is owed, and the buyer’s withholding responsibilities. We will also explore options for reducing FIRPTA tax liability, such as applying for withholding certificates and using U.S. entities. Having a solid grasp of FIRPTA will enable foreign investors to make informed decisions when buying and selling U.S. real estate.
FIRPTA Basics – What Foreign Investors Need to Know
FIRPTA was enacted by Congress in 1980 to ensure that foreign persons pay U.S. tax on gains from disposing of interests in U.S. real property. Here are some key aspects of FIRPTA that foreign investors should understand:
– Who is subject to FIRPTA? The term “foreign person” is broadly defined under FIRPTA and includes nonresident alien individuals, foreign corporations, foreign partnerships, foreign trusts, and foreign estates. So even green card holders and certain U.S. visa holders may be subject to FIRPTA.
– What transactions trigger FIRPTA? Foreign persons are taxed under FIRPTA when they sell or otherwise dispose of a U.S. real property interest (USRPI). This includes not only direct real estate sales but also distributions from a REIT or U.S. real property holding corporation. Indirect transfers can trigger FIRPTA too.
– How much tax is owed under FIRPTA? Foreign persons disposing of a USRPI are taxed at the same rates as U.S. persons – up to 37% maximum rate for individuals and 21% flat rate for corporations.
– Buyer withholding responsibilities: To enforce collection, FIRPTA requires the buyer to withhold 15% of the purchase price (10% for personal residences between $300k-$1M). Buyers must file Forms 8288 and 8288-A with the IRS and may face penalties for failure to withhold.
Strategies to Reduce FIRPTA Tax Burden
While FIRPTA imposes significant tax obligations, there are strategies foreign investors can use to minimize their FIRPTA liability:
– Apply for a withholding certificate: Sellers can apply to the IRS for a withholding certificate which reduces or eliminates the buyer’s withholding if the expected FIRPTA liability is lower than the withholding amount. This allows the seller to get back overwithheld tax more quickly.
– Use a U.S. corporation: Transferring the real estate to a U.S. corporation prior to sale avoids FIRPTA since corporations are exempt. The main exceptions are single member LLCs and other pass-through entities.
– Sell for $300k or less: No withholding is required if a foreign individual sells a personal residence for $300,000 or less and the property was used as a residence for specified periods.
– Claim treaty benefits: Some tax treaties between the U.S. and other countries reduce or eliminate FIRPTA tax for residents of those countries. Investors should consult a tax advisor about possible treaty benefits.
– Seek non-foreign certification: Sellers can provide buyers with certification of non-foreign status to eliminate withholding requirements. A qualified substitute (such as an attorney) can also certify non-foreign status.
Takeaways for Foreign Investors
FIRPTA is a complex area of U.S. tax law, but one that foreign real estate investors must understand. The key takeaways include:
– FIRPTA taxes foreign persons on gains from U.S. real property interests just like U.S. persons. Tax rates can be as high as 37% for individuals.
– Buyers are required to withhold substantial percentages of the sales price to enforce FIRPTA tax.
– Planning ahead with strategies like U.S. corporations and withholding certificates can reduce FIRPTA burden.
– Work closely with experienced U.S. tax advisors when investing in U.S. real estate to understand FIRPTA implications and optimize after-tax returns.
In summary, FIRPTA is an important law for foreign investors to be aware of when investing in U.S. real estate. While FIRPTA taxes can be significant, foreign investors have options like obtaining withholding certificates, using U.S. corporations, and selling for under $300k. Proper planning can help foreign investors minimize unfavorable tax consequences under FIRPTA.