Can a Foreign Seller Use a Section 1031 Exchange to Avoid FIRPTA Withholding- Yes Under Certain Conditions!

Can a Foreign Seller Use a Section 1031 Exchange to Avoid FIRPTA Withholding- Yes Under Certain Conditions!

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At the end of 2015, new provisions that resulted in significant changes to the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) rules regarding federal income taxes for foreign investors owning United State real estate became law. The most significant provision impacting real estate transactions involving foreign participants or non-resident aliens include increasing the FIRPTA withholding tax rate from 10% to 15% effective for dispositions after February 17, 2016. However, sellers could be exempt from withholding tax under the following three conditions:

Property to become buyers’ personal residence with sales price not exceeding $300,000

Transactions in which the IRS has issued a withholding certificate to the foreign seller

3) Seller declaration of non-recognition of gain or loss. The second exception to the FIRPTA withholding requirements is in the case of a simultaneous 1031 exchange and the transferee is not required to withhold if the “[t]he transferor gives written notice that no recognition of any gain or loss on the transfer is required because of a non-recognition provision in the Internal Revenue Code or a provision in a U.S. tax treaty.” Such a notice is called a “Declaration and Notice to Complete an Exchange” (“1031 Declaration and Notice”). A transferee can rely on a 1031 Declaration and Notice only if: (1) the foreign person completes a simultaneous exchange (i.e., the same day), and (2) the foreign person receives no cash or mortgage boot.

Under the foregoing rules, a buyer of U.S. property from a foreign person can rely on a 1031 Declaration and Notice only if the foreign person exchanges U.S. property for other U.S. property in a swap in which the foreign person receives no cash or mortgage boot. Since many exchanges can involve payment of some cash or debt reduction, the utility of a 1031 Withholding Certificate is substantially reduced.

Impact on Delayed Exchanges To the extent that the 1031 exchange is not simultaneous, or if any cash or mortgage boot will be received by a foreign person with respect to the disposition of U.S. property, the buyer can only rely on a Withholding Certificate issued by the IRS to a foreign person. As a result, foreign persons desiring to engage in a delayed 1031 exchange should consult with a FIPTA Expert and apply for an International Tax Identification Number (ITIN) and a 1031 Withholding Certificate well in advance of the anticipated disposition of U.S. property holdings.

It’s important to note that in order to rely on this declaration, the buyer must ensure that the foreign seller:

· Completes a simultaneous exchange (i.e., the same day). If this is not possible the seller must use the exception three (Seller declaration of non-recognition of gain or loss through a withholding certificate application)

· Receives no cash or mortgage boot.

NOTE: If the transaction fails either of these conditions, the buyer MUST rely on a withholding certificate, if available, or withhold the required FIRPTA Deposit.

ALSO NOTE: If it to be a completed exchange, According to the IRS,

“Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.”

Property does not qualify as like-kind if one property is in the U.S. and another is outside of the U.S..

The third exception is for transactions in which the IRS has issued a withholding certificate (literally, it is called a “Withholding Certificate”) to the foreign seller. The amount that must be withheld by a buyer can be reduced or eliminated in accord with the certificate. The seller, the seller’s agent, or the purchaser may request one, which may take 90 days or longer to obtain.

Foreign investors can still take advantage of IRS §1031 to execute a tax-deferred exchange using the third exception above, but it takes up-front planning. The first thing to do is to consult with a professional tax advisor to verify if FIRPTA applies. If so, a tax professional can assist with applying for a US taxpayer identification number and requesting a withholding certificate.

The purchaser must be notified in writing that a withholding certificate has been requested. A professional qualified intermediary should be contacted well in advance of the closing date to help prepare all necessary documentation, which must be sent to the closing attorney. Once the sale is complete, the clock begins ticking on the 45-day and 180-day exchange deadlines.

Check Out These Other Articles and Resources

FIRPTA Withholding Certificate Calculator

Done For You FIRPTA Process

FIRPTA FAQs

FIRPTA Withholding Explained

Three Really Bad Times to Discover FIRPTA

Is Every Property Under $300,000 Exempt from FIRPTA, NO!

If You Are the Realtor of the Buyer Involved in a FIRPTA Transaction, Is You Job Complete Once the Title Company Says They Have Sent the IRS a Check

Is Your Seller Foreign Under FIRPTA- Maybe Not!

Does the Buyer’s Liability End with the Signing of the FIRPTA Certification of Residential Occupancy- NO!

Does the Buyer’s Liability End with the Buyer’s Certification of Residential Use to Reduce the Seller’s Withholding Rate- NO!

Opportunities for FIRPTA Tax Withholding Reduction, Exemption, and Exclusion for an Individual Seller