Beginning February 15, 2016, the withholding tax rate has increased from the previous 10% to 15% of the amount realized by a foreign person that disposes of a “U.S. real property interest” of more than $300,000.00, according to the Foreign Investment in Real Property Tax Act (“FIRPTA”).
Enacted in 1980, FIRPTA authorized U.S government to tax foreign persons on dispositions of U.S. real property interests. One of the effects of this law is to prevent foreign sellers from escaping his/her tax liabilities by departing from the U.S immediately after the sale of property. Notably, however, different from any other tax withholding liabilities, FIRPTA requires buyer to withhold certain tax rate from the gross proceeds of the U.S real estate interest purchased from a foreign seller. In the event the buyer is a company or partnership, this legal entity will take tax withholding responsibility. Specifically, buyers, brokers or the title officers are required to serve as the withholding agents, and submit the withholding amount to IRS within 20 days of the closing. If the buyer fails to withhold, he/she may be held liable for the tax, the accrued interest and fine. Besides, the foreign seller must file final tax return following the year of sale, reporting the sales proceeds, rental income, other income and expenses, and recover the balance of cleared funds from IRS
However, not all the real estate buyers have to comply with the above-mentioned withholding tax liabilities, other factors, such as the purchase price of the property, the use of the residence, etc. have to be taken into consideration too. Please see the summery below for more information:
|The property is purchased as a personal residence and the amount realized does not exceed $300,000||No withholding tax|
|The amount realized exceeds $300,000 but no more than $1,000,000, and the property is purchased as a personal residence||10% withholding|
|The property is not purchased as a personal residence, regardless what the realized amount is||15% withholding|
Besides, buyers who meet any one of the followings are exempt from FIRPTA taxation:
1. Seller provides Non Foreign Person Certificate to buyer
2. Seller submits Withholding Certificate issued by IRS before closing, and while waiting for the approval of the withholding certificate, the buyer is authorized to hold the 10% or 15% withholding in buyer or seller attorney’s escrow account first. Once the withholding certificate is received and the amount is determined, the escrow account holder will remit the amount required by the Withholding Certificate to IRS and release the balance of the funds directly to the foreign seller; or
3. The property price is below $300,000 and it is used as personal residence, not for other purposes.
The increase of withholding tax rate demonstrates an enhancement of control on the part of IRS over real estate market involving international sellers. It further reminds buyers of the necessity to ask for identity proof from sellers before the transaction, and strictly comply with the obligation to withhold when it is required to do so. Since there are many legal issues, such as tax law and real estate law, involved in these kind of transactions, it is highly recommended for buyer to consult with experienced real estate lawyers, and cooperate closely with lawyers, accountants and title agencies in order to avoid unnecessary costs and facilitate the transaction as best as they can.