What is the IRS FIRPTA Withholding? – For Dummies

If you are a real estate agent, home buyer, or seller, you might be asking, ‘What is the IRS FIRTPA withholding?’

The IRS FIRPTA (Foreign Investment in Real Property Tax Act) withholding is a crucial aspect of U.S. tax law that affects both foreign investors and sellers of U.S. real estate. FIRPTA was enacted in 1980 to ensure that foreign individuals or entities who profit from the sale of U.S. real property are held accountable for their tax obligations.

This withholding mechanism is designed to safeguard the government’s interest in collecting taxes on the gains made from these transactions.

In this article, we will delve into the intricacies of the IRS FIRPTA withholding, explaining what it is, who it applies to, and how it functions within the broader framework of U.S. tax regulations.

What is the IRS FIRPTA Withholding?

FIRPTA stands for the US Foreign Investment in Real Property Tax Act.

In the past, when foreign sellers of real estate located in the United States owed taxes on gains from a sale, the IRS could not collect unless the seller filed a tax return.

Very often, the taxes went unpaid. In an effort to correct this problem, Congress placed the duty on the buyer to collect the tax by withholding funds from the sale.

If a seller is a foreign person and the buyer fails to withhold, the buyer may be held liable for the tax.

FIRPTA is a withholding, not a tax. Withholding is an amount held back used to pay potential taxes.

The IRS implements a withholding on foreign sellers to make sure that they pay their fair share of taxes. In other words, the IRS will hold the potential tax owed “hostage” until the seller files a tax return to show what they actually owe. Many title companies will withhold these funds.

The IRS FIRPTA withholding law considers three levels of property purchases:

1. A personal residence worth $300,000 or less – Foreign sellers currently pay no FIRPTA tax if the property was used as a residence.
   
2. A personal residence worth more than $300,000 but less than $999,999 – There is a current 10% FIRPTA tax if the property will be used as a residence. 3. Properties valued at $1 million or more – The FIRPTA tax is 15%. It doesn’t matter whether or not the property will be used as a residence.

A “foreign person” is defined under FIRPTA as a:

• nonresident alien individual,
• foreign corporation,
• partnership,
• trust or
• foreign estate

Through the FIRPTA withholding process, the Sellers can apply for a Withholding Certificate that could reduce the withholding – often reducing it to zero. Even if the Sellers are going to owe some taxes, they may be able to deduct closing costs, improvements they made to the property, and other deductions when they file the request for the Withholding Certificate with the IRS. This allows foreign Sellers to get a pre-determination either that they owe nothing, so no withholding will take place, or at least get that amount reduced.

If the Seller does nothing prior to the closing in regards to a Withholding Certificate, then the Escrow Agent or Settlement Agent will withhold the appropriate percentage of the sale proceeds at closing and remit it to the IRS. The foreign Seller can file a tax return at a later date to recoup some of that withholding.

There are a number of exemptions that would require this withholding to not be collected, but those should be discussed with your CPA to see if the seller qualifies. As with anything regarding potential taxes, it’s best to consult with a CPA, tax professional, or an attorney.

Learn more or download the IRS FIRPTA Withholding Form 8288

What Is A FIRPTA Withholding? (In Conclusion)

In conclusion, the IRS FIRPTA withholding is a vital component of U.S. tax law aimed at ensuring that foreign investors and sellers of U.S. real estate fulfill their tax obligations.

It serves as a safeguard to prevent tax evasion and promote transparency in real estate transactions involving foreign parties.

Understanding FIRPTA is crucial for both buyers and sellers involved in such transactions, as non-compliance can lead to severe penalties and legal consequences.

As the global real estate market continues to evolve, staying informed about FIRPTA and its requirements is essential for anyone engaging in cross-border property transactions in the United States.