Who would be interested in this article?

1. Foreign investors who want to sell real property located in the U.S.
2. Individual/Entity who wants to purchase real estate located in the U.S. owned by a foreign person.

The Foreign Investment in Real Property Tax Act of 1980 abbreviated FIRPTA which requires that when a foreign personal sells U.S. real estate, the transferee or buyer must withhold tax for this disposition to the IRS with 20 days of such sale. Generally, transferee must withhold 15% of the amount realized (generally the contract price) on the disposition by the transferor.  At the same time, the transferee or buyer must file Forms 8288 and 8288-A for each transferor subject to withholding. The IRS next returns the stamped copy of Form 8288-A to the transferor subject to withholding at the address shown on Form 8288-A. Copy A (for buyer) and copy B (for seller) of form 8288-A must be attached to form 8288. Copy C is for records.

Some common exceptions to the 15% withholding rule for FIRPTA

1.Withholding is required at a rate of 10% for a disposition if:

• A property which is acquired for use by the transferee as a residence, and
• The amount realized for the property is $1,000,000 or less.

A U.S. real property interest is acquired for use as a residence if:

You or a member of your family has definite plans to reside in the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the date of transfer. Do not take into account the number of days the property will be vacant in making this determination.

2.Withholding is not required for a disposition if:

• A property which is acquired for use by the transferee as a residence, and
• The amount realized for the property is $300,000 or less, and
• The actual transferee is an individual.

3.Withholding can be reduced or eliminated if:

• the transferee or the transferor seeks certification from the IRS that eliminates or reduces the withholding

There are three circumstances under which this withholding certificate can be requested:

• The seller’s ultimate tax liability is lower than the required tax withholding;
• The transferee cannot withhold that much because the payment does not involve sufficient cash or other liquid assets;
• the transferor is entitled to non-recognition treatment or is exempt from tax;

To qualify for this exception, either a transferee or transferor must obtain a certificate from the IRS excusing them from or reducing the withholding.  This certificate is requested by filing a Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests with IRS on or before the actual date the property is sold. Due to the time required for the IRS to process the application, the Form 8288-B should be filed at least 90 days prior to the closing date of the sale.

With the certificate in hand, the buyer or transferee is authorized to release the extra funds back to the transferor directly. As a result, the transferor can get the withholding back within a few months, compared to applying for a refund through filing a U.S. tax return in the following year(s).

The certificate may be issued if:

1. The withholding amount (15%,10%) exceeds the transferor’s actual maximum tax liability; or
2. The transferor is exempt from U.S. tax or nonrecognition provisions apply; or
3. the transferor and transferee enter into an agreement with the IRS for the payment of the tax.

The applicant must provide supports of expected tax liability from the sale, including support for the cost basis of the property (original settlement statements and receipts for any improvements) that were added to the property’s basis. In addition, if the property was used in a trade or business, the transferor should provide depreciation schedules and support for the adjusted basis of the property.

Once the IRS approves the Form 8288-B, it will issue an approved Withholding Certificate. If a withholding certificate application is still pending at the date of sale, Form 8288 is not due until 20 days after the IRS issues the certificate or notice of denial. 

How to Eliminate or Reduce FIRPTA Withholding?

Establish a U.S. Company:

Many local title companies or transferee will NOT be willing to wait for IRS on the withholding certificate approval due to the risks of late submission of the withholding tax amount. Therefore, it is not easy to reduce or eliminate the withholding tax by applying certificate.

Another reasonable way to avoid FIRPTA withholding tax is to “change” the transferor from foreign person into U.S. person, for example, a domestic entity. Basically, all domestic entities except disregarded entity are not subject to FIRPTA withholding tax. A disregarded entity is a single member (husband and wife are considered as one member) LLC if it not elected to be treated as corporation for tax purpose.

For how to choose the right business entity type and how to establish U.S. company, please contact us.