The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) was established in order to allow the Internal Revenue Service (IRS) to collect a capital gains tax on the realized gains from the sale of real property located in the United States by foreign individuals or businesses. The FIRPTA withholding stipulates that upon the sale of real property in the United States by a foreigner, 10 percent of the property’s sales price is to be withheld at the time of the sale in order to ensure that the United States is able to collect the applicable sales tax. Before passing FIRPTA, it was much more difficult for the IRS to collect the capital gains tax because there was little recourse should the foreign individual or business be selling the property as a result of leaving the country permanently.
Ten Percent Withholding Requirement
The 10 percent withholding is the standard amount to be withheld for all property that is sold by a foreign individual or business. This is an imperfect science because the same 10 percent would be withheld for the sale of property which saw a capital gain of 50% and a property which actually realized a 50% loss.
Example: Mario is an Italian citizen, who is selling a home that he originally purchased for $500,000. He has entered into a contract to sell the property for $600,000. Ten percent of the sales price, or $60,000, would be withheld from the proceeds of the sale to ensure that the IRS receives the applicable capital gains tax on the $100,000 increase in value. On the flip side, let’s now assume that Mario entered into a contract to sell the property for $400,000. Mario actually is losing $100,000 on the sale, but per FIRPTA withholding guidelines, $60,000 would still be withheld from the sales proceeds until the IRS reviewed the sale and determined that the amount withheld could be returned.
Withholding Certificate
The foreign seller can submit a Form 8228B to the IRS detailing the transaction information to request a FIRPTA withholding certificate. The form must be submitted prior to the sale of the property and the certificate, if granted, would allow for either a reduction or negation of the 10 percent withholding. FIRPTA stipulates that the seller would be responsible for any withholding not satisfied from the original purchase of the property and the capital gains tax from the current sale. Unfortunately, the IRS decision will typically be provided between three to five months after the form is submitted. As a result, 10 percent is required to be withheld from the sale and retained by an escrow agent until the final ruling is made. Once the FIRPTA withholding certificate is granted, the escrow agent would remit the applicable tax to the IRS and the rest would be released to the seller. The applicable tax must be sent to the IRS by the 20th day after the FIRPTA withholding certificate is mailed to the seller.
In many real property transactions, the taxpayer is initiating a 1031 exchange. The FIRPTA steps are the same with the Qualified Intermediary (QI) handling the submission of the 8288 forms and holding the ten percent in escrow. This also means the QI is responsible to the IRS for the ten percent and interaction with the IRS. In simple and complex build to suit exchanges, my experience has been the IRS is easy to work with and provides the withholding certificate to the QI when approved. It does take at least five months once all information is provided to receive a response. In each of those submitted 8288Bs submitted, a withholding certificate has been approved.
Are you selling an investment property and replacing with real property? Download a ten point 1031 exchange checklist here to make sure you are covering all the bases.
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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.
