A foreign person, including a nonresident alien individual, foreign entity or government, may be subject to a U.S. withholding tax of thirty percent on most types of U.S. sourced income. If a tax treaty exists between the U.S. and the foreign person’s country of residence, a reduced rate, including exemption, may apply. Generally, the tax is withheld from the payment made to the nonresident by a withholding agent. The withholding tax is required under sections 1441, 1442, and 1443 of the Internal Revenue Code.
Withholding Tax in a 1031 Exchange
The sale of U.S. real property interest by a foreign person is subject to a withholding tax of ten percent of the realized sales price and 35 percent of the recognized gain on distribution to shareholders for a foreign corporation under the Foreign Investment Real Property Tax Act of 1980, also known as FIRPTA. If the seller is a foreign person, the buyer may be liable for the tax if it is not withheld according to Internal Revenue Service Publication 515:
Foreign person – A foreign person is a nonresident alien individual or foreign corporation that has not made an election under section 897(i) of the Internal Revenue Code to be treated as a domestic corporation, foreign partnership, foreign trust, or foreign estate. It does not include a resident alien individual.
Transferor – A transferor is any foreign person that disposes of a U.S. real property interest by sale, exchange, gift, or any other transfer. A transfer includes distributions to shareholders of a corporation and beneficiaries of a trust or estate.
The owner of a disregarded entity, not the entity, is treated as the transferor of the property.
Transferee – A transferee is any person, foreign or domestic, that acquires a U.S. real property interest by purchase, exchange or gift, or any other transfer.
U.S. real property interest – A U.S. real property interest (USRPI) is an interest, other than as a creditor, in real property (including an interest in a mine, well, or other natural deposit) located in the United States or the U.S. Virgin Islands, as well as certain personal property that is associated with the use of real property (such as farm machinery).
A withholding certificate may be submitted to the IRS by filing form 8288B within twenty days of the property selling. If approved, the withholding tax is not submitted to the IRS. If denied, the withholding tax must be submitted within twenty days of the denial date. The certificate can take upwards of three months to receive. The withholding agent is designated as the certificate recipient, and in a 1031 exchange, is typically the Qualified Intermediary.
Treasury Section 1.1445-2(d)(2) states “a transferee shall not be required to withhold under Section Code 1445 with respect to the transfer of USRPI if the transferor notifies the transferee that the operation of a nonrecognition provision of the Code results in a tax-free transfer.” Consequently, in a 1031 exchange, the ten percent does not need to be withheld. A withholding certificate is requested with the approval rate for a 1031 exchange at an estimated 98 percent. If denied, a request for review can be submitted, postponing payment of the ten percent until resolved.
Are you a a nonresident and selling real estate in the U.S.? Are you considering acquiring a replacement property, if so, a 1031 exchange defers the capital gain and recaptured depreciation tax.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
