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Foreign Investment in Real Property Tax Act (FIRPTA) compliance

On Behalf of | Dec 6, 2022 | Tax Law |

Extra precautions are necessary when buying property in the United States from a foreign seller. This is because the Foreign Investment in Real Property Tax Act (FIRPTA) places certain tax withholding burdens on the buyer if the seller is considered a “foreign person” as defined by the Internal Revenue Code. This includes nonresident alien individuals and various foreign business entities as well as any person not a U.S. person. The government has clearly given the IRS a large amount of discretion with this broad definition.

How does this work?

In these situations, taxing authorities generally expect the buyer withhold a certain percentage of funds until the seller gets a release from the Internal Revenue Service (IRS). The exact amount the government recommends withholding varies from as low as 10% to as much as 30%. It is generally in the buyer’s best interest to withhold 30%.

Once the seller receives the release from the IRS, the buyer can transfer the funds to the seller.

If the IRS does not grant the seller the release, the IRS will expect the buyer to remit the 30% held directly to the agency. The seller would then need to file with the IRS in order to get a refund.

Why does the tax code have this requirement?

This legal tool serves to provide the U.S. government with protection to better ensure it recaptures capital gains from foreign investors when they choose to sell U.S. real estate. In the end, the IRS really does not care if it recoups those losses from the buyer or the seller. As such, it is important for the buyer to take steps to protect their interests when moving forward with these types of transactions.

What happens if the buyer fails to withhold the funds?

The IRS is known for many things — leniency is not often one of them. Unfortunately, in this situation, they will likely live up to that reputation. If the buyer fails to withhold the funds as expected by the IRS, the IRS will likely still require the buyer to come up with those funds to make the expected payment to the agency.

The moral of the story: make sure you know what you are doing. These are not simple matters. The legal complexities are difficult to navigate for even the most experienced in real estate transactions. It is generally wise to find legal counsel experienced in this niche area of tax law to mitigate the risk of a surprise bill from the IRS.