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An Overview of the Withholding Requirements for “Foreign Persons”
By Steven R. Greenberg
Effective January 1, 1985, Congress enacted FIRPTA (Foreign Investment in Real Property Tax Act). The purpose of FIRPTA is to minimize the ability of foreigners (individuals and entities) from taking the proceeds from the sale of U.S. property without paying tax on the profits.
Section 1445 of the Internal Revenue Code (“IRC”) requires that the buyer of U.S. real property collect and pay over to the Internal Revenue Service 10% of the purchase price within twenty days after the closing, unless:
1. The seller is a U.S. taxpayer and certifies under oath their social security number, or if an entity, the federal taxpayer identification number; or
2. The purchase price is $300,000.00 or less and the buyer, or a member of the buyer’s family, has definite plans to reside at the property for at least 50% of the time that the property will be used in each of the next two one-year time periods following the closing date and the buyer will sign a Residency Affidavit to that effect; or
3. The seller has applied to the Internal Revenue Service (“IRS”) for a Withholding Certificate because the seller’s tax liability will be less than 10% of the sales price. The Withholding Certificate that is issued determines the amount of the seller’s tax liability to the IRS. If the Withholding Certificate is obtained prior to closing, only the amount as reflected on the Withholding Certificate to be withheld must be paid to the IRS. If the Withholding Certificate is applied for prior to the closing date, but not yet received by the closing date, 10% of the purchase price must be withheld at closing and held in escrow pending the receipt of the Withholding Certificate. Upon receipt of the Withholding Certificate, the escrow agent pays to the IRS the amount of the tax liability and all remaining escrow funds are refunded to the seller. Of course, the Withholding Certificate procedure only makes sense in the context of a sale when the seller’s tax liability on the profit on the sale is less than 10% of the purchase price.
The FAR9 Contract Comprehensive Addendum “W” should be used when the seller is a “foreign person” as defined in the IRC (generally, a person or entity who is not a U.S. taxpayer). It should be noted that this Addendum “W” requires the buyer and seller to “execute and deliver as directed any instrument, affidavit, or statement reasonably necessary to comply with the FIRPTA requirements, including applying for a TIN (taxpayer identification number) within three days from Effective Date of the Contract and delivering this respective TIN or Social Security Number to the Closing Agent.”
There are several issues that may arise with regard to the FIRPTA withholding requirements. Depending on the amount of the liens encumbering the property and the amount of the closing costs, the seller may not net 10% of the purchase price and may have to bring money to the closing in order to close the transaction. If the seller is unable to come up with the funds necessary to meet the 10% requirement, the closing will not occur. Furthermore, if the seller is a foreign person under the IRC and the buyer initially agrees to sign a Residency Affidavit pursuant to the second exemption above, but later refuses to do so, the seller will have to comply with the obligation for withholding and may not be in a financial position to bring money to closing.
The remittance of the withheld funds to the IRS is considered the filing of a tax return; and that is why the seller is required to obtain a taxpayer identification number from the IRS. Moreover, it may still be necessary for the seller to file a tax return even if no withholding is required.
This article is intended to be a brief overview of FIRPTA. The regulations are extensive and consultation with a tax advisor is appropriate to determine requirements in any particular transaction.
Steven R. Greenberg has practiced Real Estate law in Sarasota since 1986 and is a shareholder in the law firm of Icard, Merrill, Cullis, Timm, Furen & Ginsburg, P.A. He is board certified by the Florida Bar in real property law and frequently lectures on matters involving real estate transactions. Steven may be reached at (941) 365-6216 or by calling Linda Witt, Director of Marketing, directly at (941) 586-4412 or by email at REinfo@icardmerrill.com [2].
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