What is Foreign Investment in Real Property Tax Act (FIRPTA)?
As the IRS outlines that FIRPTA is a withholding property tax when an asset is disposed of. It typically applies to foreign persons or corporations that have sold an asset. The attorney dealing with the sale of the US property will be required to withhold 15% of the property sale.
The IRS 8288 form needs to be completed to inform the IRS of the withholding tax.
Example: Sarah lives in the UK and sells a condo that is used as a holiday home. The property is sold for $350,000. The attorney has to withhold $52,500 from Sarah and transfer that money to the IRS.
What happens if the withholding tax is not paid to the IRS?
The buyer of the property could become liable for the unpaid FIRPTA if the attorney involved in the sale does not withhold the money from the seller. This is why the buyer of the property is keen to ensure that the seller pays the right amount of FIRPTA as part of the real estate property sales transaction
Why is FIRPTA such a large amount of tax to pay at 15%?
The IRS are keen to ensure that all tax due on real estate property is paid in full. They do not wish to chase someone across the Atlantic in the UK to pay the FIRPTA tax.
It is possible for the seller of the real estate property to claim back the overpaid tax on their usual 1040 tax return.
How does FIRPTA compare against property Capital Gains Tax?
The FIRPTA is clearly more of a tax liability than Capital Gains Tax for reasons explained above. The % of Capital Gains Tax will vary depending on filing status and the amount of money that you earn.
– 0% Capital Gains Tax rate for those learning less than $78,750
– 15% for those learning above $78,750 and less than $434,500 (single) and $488,850 (married), $461,700
– 20% for people that earn more than the amounts shown above.
Additionally we need to be mindful that FIRPTA of 15% is based on the sales proceeds. Capital Gains Tax is based on
– $X Sales proceeds less sales tax
– ($Y) Less the purchase cost of the real estate property.
– ($Y) Less the capital refurbishment costs cost of the real estate property.
The disposal of the US real estate property will be reported on the IRS 8949 form and the 1040 Schedule D to show the amount of gain made. The difference between the withheld FIRPTA and Capital Gains Tax liability will be refunded back to the taxpayer.
This is why it is important for foreign real estate property investors to file their IRS 1040 tax returns soon after 15th April to ensure they claim back the overpaid tax.
An example of how much more FIRPTA is paid to Capital Gains Tax
John lives in the UK and sells a holiday home in Florida. The real estate property was sold for $350,000 and was purchased in a down market for $200,000. The gain was $150,000 and is taxed at 15% due to the amount of earnings John had on hos 1040 tax return.
When John initially sold the US holiday home he paid $52,500 FIRPTAS being 15% of the $350,000 sales price.
John was able to claim back the excess tax of $30,000 FIRPTA when he submitted hos 1040 tax return.
Are there legal ways to avoid paying FIRPTA to the IRS?
The short answer is yes. This does mean there is also a longer answer
S.1455 IRC declaration that the seller is not a non-resident alien?
FIRPTA may be ignored altogether provided that a Certificate of Non-Foreiogn Status is completed. This demonstrates to the IRS that the person selling a US real estate property is not living outside the US. This gives comfort to the IRS that tax will be collected from the seller in due course on the 1040.
The buyer uses the real estate property as a home for 50% or more as a home
The seller can also avoid FIRPTA if the buyer of the real estate property declares that it is used as their main residence. In order for this FIRPTA exclusion to be granted the real estate property value must be below £300,000.
As you can see from John’s case he would still be liable for FIRPTAS withholding as the holiday home is £350,000
1031 exchange to defer FIRPTA withholding
FIRPTA may be deferred indefinitely if the seller of the US real estate property investment was to purchase another property as follows:
– Purchase one, two or three properties that has a combined value equal or greater than the selling price
– Purchase multiple properties (more than four) for twice the value of the property being sold (identified within 45 days)
Please note that the real estate property purchases must be done within 180 days of the sales transaction for the FIRPTA to be deferred.
In order to utilise the 1031 exchange contract, the seller must use a qualified intermediary.
If John was to sell the US holiday home for $350,000 he would need to buy another one, two or three US real estate properties for $350,000. Alternatively, John could buy a multi-home complex for $700,000