Tax Withholding for US Nonresidents Selling US Real Estate (FIRPTA)
This could be useful if you are a buyer or a seller currently perusing the real estate market. In Phoenix (home of American Tax Compliance), it seems like the economic conditions are good for sales, and the weather is at its best all year - you probably already know this. What you may not know, is that there could be a hurdle between you and that perfect deal.
If you are a US nonresident selling real estate, or a buyer purchasing real estate from a nonresident, there is an extra step to deal with - the IRS. FIRPTA, or the Foreign Investment in Real Property Tax Act, is the set of IRS laws which apply to US nonresidents selling US real estate. The default withholding rate for US nonresidents is 15% of the gross proceeds of the sale, which can be onerous because the actual tax due to the IRS (when you file a return) is based upon the net proceeds, which is the gross proceeds after deducting the original purchase price and costs of sale.
Tax professionals who work with FIRPTA, such as myself, often request a withholding certificate (Form 8288-B) to reduce the withholding from 15% of gross proceeds to 15% or 20% of net proceeds (these are the US tax rates for long-term capital gains, which just means most people buy their property and hold it for at least one year). The process might seem to be straightforward, but there is a twist: The buyer is responsible for withholding the required rate of tax at the time of closing. This is a strange rule, but it is based primarily on the fact that the IRS does not have tax identification numbers for nonresidents to require them to file a US tax return, which is needed to report the taxable gain from property and pay tax to the IRS. While the nonresident sellers may file Form W-7 (which is an application for US tax identification numbers), to obtain the tax identification numbers, the obligation to withholding tax at closing stays with the buyer. The IRS does not rule by logic alone, but frequently based on administrative ease.
If the application for a withholding certificate is filed prior to closing, the 15% gross tax withholding need not be remitted to the IRS at the date of closing, but at the option of the buyer it may be held in escrow until the IRS issues its determination letter stating whether a withholding certificate is approved or denied. There is no penalty to the buyer if the withholding certificate is denied, but if the buyer does not provide their name, address, and social security numbers to complete the withholding certificate application, the seller will usually have to wait until the following calendar year to claim a refund of the excess tax withheld by the IRS (by filing a nonresident return). Not the best outcome if it can be avoided.
The situation that develops is a little bit like a trust fall. The buyer and the seller should work together to make sure that they select a good title company, and a tax advisor to steer them through the process. There are plenty of well-established title companies that muddy the waters from their inexperience with FIRPTA - and even large public accounting houses that deal with foreign reporting balk at these issues. Our advice is not to let anyone mess up your tax filings, even if they are willing to mess them up for free.
As always, feel free to post any questions you may have below. IRS nonresident tax withholding on real estate transactions is an important, if not easily intelligible, issue.
