Opportunities for FIRPTA Tax Withholding Reduction, Exemption, and Exclusion for an Entity Seller
Check out this explainer video
The Foreign Investment in Real Property Tax Act, known as FIRPTA, subjects a foreign seller of U.S. real estate to a withholding of 15% of the gross sales price. This withholding is deducted from the net proceeds due to the seller and must be remitted to the Internal Revenue Service (I.R.S.) no later than 20 days after closing.
While most of the time, the determination of the foreign status of a seller is clear, there are times when this status is not quite so obvious. This is often the case when the seller is a limited liability company (L.L.C.) formed in the U.S.
As illustrated below, a US LLC can be taxed in a variety of ways, depending on the particular circumstances:
Domestic Corporations are not subject to the withholding rules of FIRPTA. Suppose a foreign corporation or single-member limited liability company that would normally be under FIRPTA checks the box on the form to be taxed as a domestic corporation. In that case, withholding won't be required. The entity must file Form 8832 with the I.R.S., get I.R.S. approval, and give the buyer evidence. The buyer should keep a copy of this for at least five years.
A domestic corporation must withhold tax on the fair market value of the property distributed to a foreign shareholder if:
- The shareholder's interest in the corporation is a U.S. real property interest, and
- The property distributed is either in the redemption of stock or in the corporation's liquidation.
For distributions before February 17th, 2016, the corporation generally must withhold 10% of the amount realized by a foreign person. For distributions after February 16th, 2016, the rate increases to 15%.
A Foreign Corporation that distributes a U.S. real property interest must withhold a tax equal to 21% (35% for distributions before January 1st, 2018) of the gain it recognizes on the distribution to its shareholders.
The I.R.S. will withhold this amount until it has verified that all taxes due by the non-resident are paid. If applicable, foreign investors can apply for a refund of the excess withheld amount by filing a U.S. tax return in the year following the sale. There are also other exceptions for the FIRPTA withholding that may apply under certain circumstances.
Limited liability company with one owner (known as a single-member L.L.C.)
A single-member L.L.C. is a legitimate legal entity but defaults to being disregarded for U.S. income tax reporting purposes. Any U.S. income tax reporting is done in the owner's name, not the name of the L.L.C. For example, if a foreign individual is the only owner of a US LLC, the U.S. income tax reporting is done in the name of the foreign individual. In this situation, the FIRPTA withholding rules would apply as the seller, for purposes of FIRPTA, is the foreign individual, not the US LLC. The same would hold true if the single owner were a foreign corporation instead of an L.L.C. electing to be taxed as a corporation.
Limited liability company with more than one owner
A US LLC with more than one owner defaults to being taxed as a partnership for U.S. income tax reporting purposes. The withholding rules under FIRPTA do not apply to U.S. L.L.C.s taxed as partnerships, as this does not fall under the definition of a foreign seller. Other withholding rules apply in this situation (withholding rules pertaining to partnerships with foreign partners). Still, this withholding is done at the L.L.C. level, not at the level of the sale of the U.S. real estate owned by the L.L.C. taxed as a partnership.
Limited liability company making a "check the box" election
Whether a US LLC has only a single owner or multiple owners, it can make an election to be taxed as a U.S. corporation by filing Form 8832, Entity Classification Election, with the I.R.S. If approved by the I.R.S., the US LLC would file income tax returns reporting as a U.S. corporation. The tax status of the owner(s) is not a factor in determining the tax status of the L.L.C. that has elected to be taxed as a U.S. corporation. If the L.L.C. chooses to be taxed as a corporation, the FIRPTA rules will not apply, even if it is 100% owned by one non-resident alien (N.R.A.) A US corporation is not subject to the withholding rules under FIRPTA as it is not considered a foreign seller.
As you can see, when dealing with U.S. limited liability companies, the applicability of the FIRPTA withholding is not evident, and further inquiries are needed to make the determination.
Since every situation is unique, we are happy to advise you on the options available to you in complying with this requirement on the sale of your property.
Additional Exceptions
What about the $300,000 Exception Rule?
Multiple conditions would apply, but one of the most typical is if the buyer is a U.S. person that will be living there (or a member of the family) at least 50% of the days in the consequent two years and the sales price is less than $300,000
Corp Certifies That the Interest is Not U.S. Real Property
The disposition is of an interest in a domestic corporation. That corporation furnishes you a certification stating that the interest is not a U.S. real property interest under penalties of perjury. In most cases, the corporation can make this certification only if either of the following is true.
During the previous five years (or, if shorter, the period the interest was held by its present owner), the corporation was not a USRPHC.
Withholding on foreign partner's effectively connected taxable income (ECTI)
Suppose, during a partnership's tax year the partnership has taxable income effectively connected with the conduct of a trade or business within the United States that is allocable to a foreign partner. In that case, the Internal Revenue Code requires the partnership to report and pay a withholding tax under I.R.C. Section 1446 to the I.R.S. The partnership must pay the I.R.C. section 1446 withholding tax regardless of the amount of foreign partners' ultimate U.S. tax liability and regardless of whether the partnership makes any distributions during its tax year. Revenue Procedure 92-66, and Treasury Regulation section 1.1446-3 set forth the time and manner for paying the withholding tax and the general reporting obligations with respect to the tax. Refer to Form 8804, Annual Return for Partnership Withholding Tax (Section 1446), Form 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax, and Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446), for further guidance on reporting and paying the I.R.C. section 1446 withholding tax. A partnership that fails to comply with I.R.C. section 1446 reporting and withholding requirements may be subject to penalties and interest.
The partnership may reduce the foreign partner's share of the partnership's gross effectively connected income by certain partner-level deductions and losses if the foreign partner certifies these losses on Form 8804-C, Certificate of Partner-Level Items to Reduce Section 1446 Withholding (see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, for additional information).
Special rules apply to publicly traded partnerships. Publicly traded partnerships (within the meaning of Rev. Proc. 89-31) must file Forms 8804, 8805, and 8813 only if they have elected to pay I.R.C. section 1446 withholding tax based on effectively connected taxable income allocable to its foreign partners. For more information about the rules applicable to publicly traded partnerships, see Revenue Procedure 92-66.
Fixed or determinable annual or periodical (FDAP) income
A partnership may have to withhold tax on a foreign partner's distributive share of fixed or determinable annual or periodical gains and income (FDAP income) not effectively connected with a U.S. trade or business, as well as withhold on any other FDAP income paid to a foreign person regardless of whether he is a partner or not (N.R.A. Withholding). Report this type of withholding on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form(s) 1042-S, Foreign Person's U.S. Source Income Subject to Withholding. Refer to Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, and to the Instructions for Form 1042-S.
Withholding under the Foreign Investment in Real Property Tax Act (FIRPTA)
Suppose a partnership acquires a U.S. real property interest from a foreign person. In that case, the partnership may have to withhold tax under I.R.C. section 1445 (FIRPTA) on the amount it pays for the property (including cash, the fair market value of other property, and any assumed liability).
Withholding on a foreign partner's sale of a partnership interest
A purchaser of a partnership interest, which may include the partnership itself, may have to withhold tax on the amount realized by a foreign partner on the sale of that partnership interest if the partnership is engaged in a trade or business in the United States, as per new section 1446(f) of the Internal Revenue Code that was added by section 13501 of P.L. 115-97. For withholding, payment, and reporting requirements under section 1446(f), see the Instructions for Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and Notice 2018-29 (or any future published guidance).
Withholding under the Foreign Account Tax Compliance Act (FATCA).
A partnership may have to withhold tax on distributions to a foreign partner of a foreign partner's distributive share when it earns withholdable payments. A partnership may also have to withhold on withholdable payments that it makes to a foreign entity. See sections 1471 through 1474 of the Internal Revenue Code. A partnership that has a duty to withhold but fails to withhold may be held liable for the tax, applicable penalties, and interest. See section 1461 of the Internal Revenue Code.
Coordination of I.R.C. Sections 1445 and 1446(a)
A domestic partnership that is otherwise subject to the withholding requirements of I.R.C. sections 1445 (FIRPTA) and 1446 (partnership withholding) will be subject to the payment and reporting requirements of I.R.C. section 1446 only and not I.R.C. section 1445 with respect to partnership gain from the disposition of a U.S. real property interest. A partnership that has complied with the requirements of I.R.C. section 1446 will be deemed to satisfy the withholding requirements for FIRPTA. However, a domestic partnership that would otherwise be exempt from I.R.C. section 1445 withholding by operation of a nonrecognition provision must continue to comply with the FIRPTA requirements (see Treasury Regulation section 1.1445-5(b)(2)). In the event that amounts are withheld under FIRPTA at the time of the disposition of a U.S. real property interest, such amounts may be credited against the partnership's 1446 tax. A partnership that fails to comply fully with the requirements of I.R.C. section 1446 may be liable for any unpaid 1446 tax and subject to any applicable addition to the tax, interest, and penalties under I.R.C. section 1446. A foreign partnership that is subject to withholding under I.R.C. section 1445(a) (FIRPTA) during its taxable year may credit the amount withheld under I.R.C. section 1445(a) against its I.R.C. section 1446 tax liability for that taxable year only to the extent such amount is allocable to foreign partners. Refer to Treasury Regulation section 1.1446-4(f)(4) for rules coordinating the withholding liability of publicly traded partnerships under I.R.C. sections 1445 and 1446.
Are You Paying Your Installment Payments Properly?
When you pay the withholding tax required under I.R.C. section 1446, carefully follow the guidance provided in Instructions for Forms 8804, 8805, and 8813.
Use Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446), to pay quarterly installments of withholding tax under I.R.C. section 1446 to the United States Treasury. Form 8813 must accompany each payment of I.R.C. section 1446 tax made during the partnership's tax year.
File Form 8813 on or before the 15th day of the 4th, 6th, 9th, and 12th months of the partnership's tax year for U.S. income tax purposes.
Mail the voucher with a check or money order in U.S. currency payable to the "United States Treasury." Write the partnership's Employer Identification Number, tax year, and "Form 8813" on the check or money order.
File Form 8813 with:
Internal Revenue Service Center
P.O. Box 409101
Ogden UT 84409
Generally, pay any additional amounts due when filing Form 8804. However, if the partnership files Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns, to request an extension of time to file Form 8804, pay the balance of I.R.C. section 1446 withholding tax estimated to be due with Form 7004 in order to avoid the late payment penalty. The use of Form 7004 does not automatically extend the time for payment of the tax due.
Filing in accordance with the instructions will ensure the payments are credited to the proper account.
Submitting a payment with Form 8813 does not totally satisfy the partnership's responsibility for filing. In addition, the partnership must file Form 8804 with the I.R.S. and Form 8805 with the I.R.S. and the foreign partner after the end of the partnership's calendar or fiscal year.
Is It Time to Update Foreign Partners' U.S. TINs'?
For a foreign partner to claim a refund, a valid Taxpayer Identification Number (TIN) is required. A foreign partner must file an income tax return (Form 1040NR, Form 1120F, etc.) with a valid TIN. Note that Individual Taxpayer Identification Numbers (ITINs) that haven't been included on a U.S. federal tax return at least once in three consecutive years will expire. In addition, certain ITINs will expire according to an annual schedule based on the middle digits of the ITIN (Refer to Publication 1915, Understanding Your I.R.S. Individual Taxpayer Identification Number (ITIN)PDF for details). You need to take action to renew it if it is included on a U.S. federal tax return.
Are Your Foreign Partners Aware of This?
This is especially important with respect to partnership withholding. A foreign or domestic partnership (other than a publicly traded partnership) that has effectively connected taxable income allocable to a foreign partner must pay a withholding tax under I.R.C. section 1446 equal to the applicable percentage of the effectively connected taxable income that is allocable to its foreign partners. A partnership must pay the withholding tax for a foreign partner even if the partnership does not have a U.S. TIN for that partner.
Foreign partners must attach Copy C of Form 8805 to their U.S. income tax returns to claim a credit for their share of the I.R.C. section 1446 tax withheld by the partnership. To ensure proper crediting of the withholding tax when reporting to the I.R.S., a partnership must provide a U.S. TIN for each foreign partner. The partnership should notify any of its foreign partners without a valid TIN of the necessity of obtaining a U.S. TIN. An individual's TIN is the individual's social security number (SSN) or ITIN. An ITIN is a nine-digit number that will always begin with a 9, is formatted like an SSN, and has the fourth and fifth digits in the range of "50" to "65", "70" to "88", "90" to "92" or "94" to "99". It is also possible that a partner's TIN could be its U.S. employer identification number (E.I.N.).
NOTE: Certain aliens who cannot obtain SSNs can now apply for ITINs on Form W-7, Application for I.R.S. Individual Taxpayer Identification Number.
Partnerships should review their files and/or contact their foreign partners to verify that each foreign partner has a valid TIN.
References/Related Topics
- Partnership Withholding
- N.R.A. Withholding
- Reporting and Paying Tax on Partnership Withholding
- Instructions for Form 8288
- Instructions for Forms 8804, 8805, and 8813
- ITIN Expiration Frequently Asked Questions
- Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities,
- Publication 541, Partnerships
- Publication 1915, Understanding Your I.R.S. Individual Taxpayer Identification Number (ITIN)PDF
Note: This page contains one or more references to the Internal Revenue Code (I.R.C.), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable I.R.C. sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24th, 1995, visit the Opinions Search page of the United States Tax Court.
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