Does the Buyer’s Liability End with the Buyer’s Certification of Residential Use to Reduce the Seller’s Withholding Rate- NO!
Check out this explainer video
In February 2016, the Treasury issued new regulations that allow for a reduced withholding rate of 10% for properties with a purchase price of more than $300,000, but less than $1 million. This 10% withholding rate is available if: (a) the purchase price of the property is more than $300,000, but does not exceed $1 million, and (b) the buyers are willing to certify that they (or a family member) intend to reside in the property for at least 50% of the time that the property will be in use during the first 24 months following closing. This exception carries with it all of the same issues, risks, and dangers to the buyer that the Buyer Certification of Residential Use does.
First, it is important to note that the buyer’s certification only exempts the buyer from the withholding requirements. It does not exempt the seller from paying tax. Therefore, the seller will still be responsible for filing a tax return and paying the full amount of any tax due. If the seller fails to do so, all parties to the closing could face the consequences.
The certification carries significant risks for the buyer and, by extension, for the closing agents, real estate agents, and brokers.
If the seller does not pay the required tax, the buyer could be liable for the tax not withheld unless the buyer takes significant steps to monitor and encourage the seller’s compliance with the tax laws.
If the buyer fails to meet the occupancy requirements, then the buyer could be liable for the tax not withheld. In other words, the buyer could wind up personally owing the IRS up to 15% of the purchase price, plus interest and penalties. Of course, as mentioned before, the buyer will then look to the closing agent, attorneys, real estate agents, and brokers for reimbursement, claiming that the latter parties were professionally negligent in allowing the buyer to sign the certification.
In evaluating whether or not to take this risk, there are certain factors that the buyer (and their Realtors®) will want to consider:
- If the seller for any reason does not pay the tax, then the buyer will be liable for the withholding, unless the buyer takes significant steps to monitor and encourage the seller’s compliance with the tax laws.
- If the buyer does not live in the property for at least 50% of the time that it is in use during the first 24 months following closing, then the buyer will be liable for the withholding, unless the buyer can prove to the IRS that the buyer could not have “reasonably foreseen” the circumstances that prevented the buyer from living in the property, at the time the buyer signed the certification. Recent changes in IRS policy have increased this burden of proof on the buyer and therefore heightened the risk that buyers will be held liable if the buyers does not live in the property at least 50% of the time over the two year period.
Examples of potential “reasonably unforeseen circumstances:
- Buyer loses his/her job after closing and has to sell the property as a result
- A relative has a chronic illness and that illness worsens afterwards, requiring the buyer to move the relative out of the purchased property
- Buyer receives a promotion and is required to move yet again, unless there is a history of frequent moves.
- Finally, what if a buyer purchases the property, moves in, really dislikes the neighborhood and/or the neighbors, and decides to move out within 24 months. It is questionable whether the IRS will see this as an unforeseen circumstance.
Is the buyer willing to gamble on what the IRS will decide was “reasonably foreseeable” in any of these scenarios?
Even if buyer does ultimately prove that their failure to reside in the property was not reasonably foreseeable (and thus avoid actual withholding liability), they will have spent significant time, worry, and attorney’s and CPA’s fees doing it.
Title insurance will not provide buyers with any coverage for a FIRPTA claim, nor will it reimburse them for their expenses in defending against one, because FIRPTA compliance is not considered a title matter.
How Does the Buyer takes Significant Steps to Monitor and Encourage the Seller’s Compliance with the Tax Laws.
As part of our FIRPTA process Legacy Tax $ Resolution Services obtains an IRS Power of Attorney (Form 2848) signed by the Seller. The IRS Power of Attorney allows us to monitor the significant events in the FIRPTA Process. These significant events are:
- FIRPTA deposit applied to the correct seller IRS account
- Filing of the appropriate tax return by the seller
- Acceptance of the tax return filed by the seller
With the seller written permission in a document obtained from the seller, we will inform all of the parties that have a vested interest in the FIRPTA Process (Buyer, Seller, Realtor, Title Company, Broker, Attorneys) of these events.
What Is The Other Option for the Buyer Regarding Exposure to Liability in the FIRPTA Transaction?
Nothing in FIRPTA requires the buyer to sign the certification, nor does the buyer get any compensation for signing it. In other words, agents who encourage their buyers to sign a certification could be telling them to take on a tremendous risk that they are not contractually obligated to take and that they will not be compensated for taking. Remember, the buyers facing a large IRS tax liability will be eager to point fingers at any other parties involved in the transaction – including the closing agent and the real estate agents, brokers and attorneys. Any of these parties who advised the buyers to sign the certification, or who failed to disclose its risks, could then be forced to share that tax liability with the buyers through malpractice or negligence lawsuits.
Based on these risks, the safest course for buyers, closing agents, and Realtors® is to encourage foreign sellers to apply for a withholding certificate directly from the IRS (as described above) or to comply with the 15% withholding requirement, rather than relying on the buyer’s certification.
If, however, it happens that the buyer is absolutely certain that the buyer or a family member will reside on the property for 50% of the time the property is occupied for the first 24 months after closing, the seller is adamant about not complying with, or is unable to comply with, the FIRPTA or ITIN requirements and/or the buyer believes the buyer is receiving adequate consideration under the terms of sales transaction (e.g., a great price, a one-of-a-kind property, etc.) for taking the risk of signing a buyer’s certification, the buyer may be willing to sign the certification as a part of the deal. In such a case, because of the serious risks to Realtors®, their brokers, closing agents and attorneys, we recommend that the Realtors® have the buyer sign the FIRPTA Risk Disclosure Addendum to Real Estate Contract. (Please note that the use of this Addendum is no guarantee against the filing of a lawsuit or against the incurring of any losses, expenses, or damages in connection with the issues discussed in this article.)
Check Out These Other Articles and Resources
FIRPTA Withholding Certificate Calculator
Three Really Bad Times to Discover FIRPTA
Is Every Property Under $300,000 Exempt from FIRPTA, NO!
Is Your Seller Foreign Under FIRPTA- Maybe Not!
Definitions of Terms and Procedures Unique to FIRPTA
Who Is Considered a Foreign Seller under FIRPTA
Can the Buyer Rely of the Seller’s Certification That They are not a Foreign Person?
Opportunities for FIRPTA Tax Withholding Reduction, Exemption, and Exclusion for an Entity Seller