FIRPTA Form 8288 – Foreign Person & U.S. Real Estate | IRS Withholding
What is FIRPTA?
FIRPTA is the Foreign Interest in Real Property Act. Since many of our clients are foreigners who have an interest in property in the United States, we wanted to provide a summary of what the current state of the law is regarding the ownership/sale of real property.
While FIRPTA itself may not impact IRS Offshore Voluntary Disclosure directly, it may have an indirect impact on additional reporting responsibilities.
That is because depending on how the deal for the sale of U.S. Real Estate is structured, and what methods for withholding money are utilized, either party to the transaction may find themselves (now or in the future) with an IRS Foreign Reporting Requirement, on forms such as a FBAR, Form 8938, 5471, 8865, or 8621.
If you are a Foreign Person (or a U.S. Withholding Agent) it is important to have at least a basic understanding of these laws.
Foreign Ownership of U.S. Property
The main purpose behind FIRPTA is the idea that if a foreign person owns US property and sells it, but does not otherwise have to file a tax return, will that person pay tax on the capital gain? (Read: they wouldn’t if FIRPTA was not enacted).
That is because while there are many tax exemption/exclusion rules for foreigners owning and selling property in the United States (aka Capital Gain) to having to pay U.S. tax on the sale, when it comes to real estate the typical rule is that the owner of the real estate pays capital gains, even if the person is a foreigner.
Who is Considered a Foreign Person?
Since the U.S. likes to keep term “U.S. Person” intentionally ambiguous, there is no reason why the IRS wouldn’t also keep the term “Foreign Person” ambiguous as well.
As provided by the IRS, a Foreign Person for FIRPTA includes “A nonresident alien individual, a foreign corporation that does not have a valid election under section 897(i) to be treated as a domestic corporation, a foreign partnership, a foreign trust, or a foreign estate. A resident alien individual is not a foreign person. A qualified foreign pension fund or any entity wholly owned by such fund that disposes U.S. real property interest or receives a distribution from a REIT is not a foreign person. See sections 897(l) and 1445(f)(3) for more information.
*In general, if the person is a non-U.S. Citizen, Legal Permanent Resident or person who meets the Substantial Presence Test (and sometimes even if they have in prior years), will be considered a Foreign Person.
What is a U.S. Real Property Interest?
Often times, the IRS defines something, by providing a description, and then clarifying what is not included. Welcome to the wonderful, confusing, and confounding world of the IRS.
Any interest, other than an interest solely as a creditor, in: 1. Real property located in the United States or the U.S. Virgin Islands. 2. Certain personal property associated with the use of real property. 3. A domestic corporation, unless it is shown that the corporation was not a
U.S. real property holding corporation during the previous 5 years (or during the period in which the transferor held the interest, if shorter).
A U.S. real property interest does not include:
– An interest in a domestically controlled qualified investment entity.
– An interest in a REIT that is held by a qualified shareholder. For the definition of a qualified shareholder see section 897(k)(3). But see section 897(k)(2)(B) for the cut-back rule if the qualified shareholder has one or more applicable investors.
– An interest in a corporation that: Did not hold any U.S. real property interest as of the date the interest in such corporation is disposed, Has disposed of all its U.S. real property interests in transactions in which the full amount of any gain was recognized as provided in section 897(c)(1)(B), and neither such corporation nor any predecessor of such corporation was a REIT or a RIC at any time during the shorter of the previous 5 years or the period in which the transferor held the interest.
– An interest in certain publicly traded corporations, partnerships, and trusts. See Regulations sections 1.897-1 and 1.897-2 for more information.
What is Capital Gain?
A relatively simple example of Capital Gain is the following: when a person owns a property and sells it there is typically a gain (aka Increase or Profit) which is then considered capital gain. For example, if David purchases a property for $100,000 and sells it to Michelle for $130,000 he has achieved a $30,000 capital gains.
The capital gain is typically taxed at 15% unless David lands in the highest tax bracket in which that amount increases to 20% (the capital gains rates can change it should). If David held the property for less than year, it is considered short-term capital gain and taxed at David’s ordinary tax rate.
When a person is selling real estate, and the person is a non-U.S. Person, the main concern for the IRS is to ensure that the foreigner pays capital gains tax, if any that exists on the increase in value of the sale. As in the example above, David has $30,000 of gain, which would be taxed at either $4500 or $6000, depending on David’s tax bracket (we’re presuming David held the property for more than a year)
If David is a non-US person, non-legal permanent resident who does not meet the substantial presence test, David does not have to otherwise file a U.S. Tax Return. Therefore, who is going to ensure that David pays tax on the additional capital gain?
If you are the buyer, the IRS as opposed this requirement on you — or you broker.
As provided by the IRS: “A withholding obligation under section 1445 is generally imposed on the buyer or other transferee (withholding agent) when a U.S. real property interest is acquired from a foreign person. The withholding obligation also applies to foreign and domestic corporations, qualified investment entities, and the fiduciary of certain trusts and estates. This withholding serves to collect U.S. tax that may be owed by the foreign person. Use Form 8288 to report and transmit the amount withheld.”
Who files form 8288?
Unfortunately, it is not limited to individuals. Rather, “A buyer or other transferee of a U.S. real property interest, and a corporation, qualified investment entity, or fiduciary that is required to withhold tax, must file TIP Form 8288 to report and transmit the amount withheld. If two or more persons are joint transferees, each is obligated to withhold. However, the obligation of each will be met if one of the joint transferees withholds and transmits the required amount to the IRS.”
When is Form 8288 Filed?
Form 8288 must be filed by the 20th day after the date of the transfer. In other words, the IRS is not going to sit around waiting for the transferee to file this form. As provided specifically by the IRS “A transferee must file Form 8288 and transmit the tax withheld to the IRS by the 20th day after the date of transfer. You must withhold even if an application for a withholding certificate is or has been submitted to the IRS on the date of transfer.
However, you do not have to file Form 8288 and transmit the withholding until the 20th day after the day the IRS mails you a copy of the withholding certificate or notice of denial. But, if the principal purpose for filing the application for a withholding certificate was to delay paying the IRS the amount withheld, interest and penalties will apply to the period beginning on the 21st day after the date of transfer and ending on the day full payment is made.”
Installment Payment Purchase/Sales
This is a very important concept. Oftentimes, a sale may result in a installment sale in which the purchaser pays a certain amount of the main price in installments. This usually comes with additional interest being accrued on the purchase price, since the transferee will not be receiving a lump sum at one time.
Nevertheless, the IRS wants their money now. Therefore, “You must withhold the full amount at the time of the first installment payment. If you cannot because the payment does not involve sufficient cash or other liquid assets, you may obtain a withholding certificate from the IRS. See the instructions for Form 8288-B for more information.
Don’t Forget Form 8288-A
In addition to form 8 288, the filer must also complete a form 8288-A (Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests) for each person subject to withholding. Copies A and B of Form 8288-A must be attached to Form 8288. Copy C is for your records. Multiple Forms 8288-A related to a transaction can be filed with one Form 8288. You are not required to furnish a copy of Form 8288 or 8288-A directly to the transferor.
Not everyone transferee of U.S. property from a Foreign Person has to file Form 8288.
Purchase of Residence for $1,000,000 or Less
Withholding is required at a reduced rate of 10% in the case of a disposition of: A property which is acquired by the transferee for use by the transferee as a residence, and The amount realized for the property is $1,000,000 or less.
See Purchase of residence for $300,000 or less next.
Withholding Not Required
Purchase of Residence for $300,000 or less
If one or more individuals acquire U.S. real property for use as a residence and the amount realized (in most cases the sales price) is $300,000 or less, no withholding is required. 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. No form or other document is required to be filed with the IRS for this exception; however, if you do not in fact use the property as a residence, the withholding tax may be collected from you.
This exception applies whether or not the transferor (seller) is an individual, partnership, trust, corporation, or other transferor. However, this exception does not apply if the actual transferee (buyer) is not an individual, even if the property is acquired for an individual.
Eliminate Withholding or Reduce Withholding
Withholding certificate issued by the IRS. A withholding certificate may be issued by the IRS to reduce or eliminate withholding on dispositions of U.S. real property interests by foreign persons. Either a transferee or transferor may apply for the certificate. The certificate may be issued if:
– Reduced withholding is appropriate because the 10%, 15%, or 35% amount exceeds the transferor’s maximum tax liability,
– The transferor is exempt from U.S. tax or nonrecognition provisions apply, or
– The transferee or transferor enters into an agreement with the IRS for the payment of the tax.
An application for a withholding certificate must comply with the provisions of Regulations sections 1.1445-3 and 1.1445-6, and Rev. Proc. 2000-35, 2000-35 I.R.B. 211.