FIRPTA and 1031 Exchange

As a result of the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), the United States can tax foreign businesses and individuals on the disposal of real property (real estate) located in the United States. The reason for FIRPTA is to ensure the collection of capital gains taxes that it would previously not be able to pursue if the seller was a foreign individual or entity.

Ten Percent Withholding Tax

FIRPTA stipulates that upon the sale of the domestic property, 10 percent of the gross sales price must be withheld towards payment of the potential capital gains tax. This 10 percent rule is standard, regardless of the actual amount of gain or even loss that would be taxable. A foreigner with no connection to the United States other than owning one piece of real property may have little incentive to follow United States tax laws, which is why FIRPTA was enacted.

  • Example: Frank, a German citizen, owns one property in the United States and decides to sell it for $300,000 after originally purchasing it for $200,000. FIRPTA requires 10 percent of the gross sales price ($30,000) to be withheld from the sale to pay for the potential capital gains tax on the gain. Now, let’s say Frank originally purchased the property for $400,000. The property actually decreased in value, so Frank would not owe any capital gains tax, but he would still be responsible for having the 10 percent withheld from the gross sales price. Upon Frank filing his non-resident tax return, he would claim the 10 percent as a tax credit on his return.

Another characteristic of FIRPTA lies in the responsibility. It is the responsibility of the non-resident alien individual or corporation to have the 10 percent withheld from the sale first and foremost, but as mentioned above, many times, there is little motivation for them to actually do so if it doesn’t come up in negotiations. If the foreign property owner does not have the 10 percent withheld, the purchaser may actually become responsible for paying the 10 percent. This is why it is very important for anyone purchasing real property to have a discussion with the seller as to whether he/she is a foreign citizen or a foreign business. Title companies and real estate attorneys require a certificate of non-foreign status be signed under penalty of perjury that the seller is a non-resident alien individual or corporation.

  • Example: Using the same example as above, let’s say Frank does not comply with the certificate of non-foreign status. Joe, the buyer, and a United States citizen, isn’t aware of FIRPTA (as is very common), and doesn’t even think to ask the question, thus 10 percent of the sales price is not withheld to cover the potential capital gains tax. The IRS discovers that the property was sold without a capital gains tax being collected and after doing some research, discovers that Frank has no other means of connection with the United States, and holds little leverage over him in collecting that tax. It’s for this reason FIRPTA states that the United States can actually make the buyer responsible for such payment.

Withholding Certificate

There are a few situations in which the FIRPTA withholding can be waived, such as if the Buyer buys the real property interest as their personal residence and the transaction is $300,000 or less, or if the foreigner receives a withholding certificate, among other reasons outlined by the IRS.

Atlas 1031 Exchange has submitted and received IRS approval on many withholding certificates for foreign taxpayers engaged in a 1031 exchange. Contact us with your questions by clicking on the button below.