Opportunities for FIRPTA Tax Withholding Reduction, Exemption, and Exclusion for an Individual Seller
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Not a Foreign Person Exception
The buyer may accept an affidavit from the seller that states they are NOT a Foreign person. Without proper documentation, taking this on faith would be risky for the buyer.
Four Easy Ways to Determine
- Have a US Passport- Not Foreign
- Have a US Birth Certificate- Not Foreign
- Have US Naturalization Documents- Not Foreign
- Long-term Permanent Resident Visa- Green Card- Not Foreign
One Difficult Way to Determine
Substantial Presence Test
We count the number of days in a three-year look back period, if it equals 183 days and they're not here on an exempt visa (exempt from the substantial presence test)- Not Consider Foreign.
Personal Residence Exclusion
This exemption is available if: (a) the purchase price of the property is not more than $300,000, (b) the buyers is 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. If the buyers sign this certification, then the transaction is exempt from FIRPTA withholding. While this sounds like a quick and easy avenue to FIRPTA compliance, it is actually very dangerous for the buyer. Recent IRS changes now make it even more risky.
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 b
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.
Reduced Rate of Withholdings Exclusion
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.
Seller Withholding Certificate
According to IRS.gov, the withholding amount on the sale of US property can be adjusted if the IRS issues a withholding certificate. A withholding certificate is an application for a reduced withholding based on the gain of a sale instead of the selling price.
If 15% of the selling price is more than the tax you will owe on this sale, then a withholding certificate may be ideal for you.
Important features to know about withholding certificate applications:
- If the withholding certificate can’t be applied for and issued prior to closing, then typically the buyer gets to decide if the funds need to be remitted within 20 days of the closing or if they can remain in escrow pending the approval or rejection of the application.
- The IRS will generally act on these requests within 90 days after receipt of a complete application
- All parties must have or at least apply for a US tax ID for a withholding certificate
- The applicant must be able to prove their basis in the property
- The transferee (buyer), the transferee’s agent (Realtor), or the transferor (seller) may request a withholding certificate.
- A transferor that applies for a withholding certificate must notify the transferee in writing that the certificate has been applied for on the day of or the day prior to the transfer.
Foreign investors are often interested in what U.S. tax planning opportunities may be available to mitigate the impact of the FIRPTA withholding tax requirement. A highly effective way to minimize a foreign seller’s FIRPTA withholding tax liability is to file a U.S. federal Form 8288-B application for a FIRPTA withholding tax exemption certificate.
If the seller’s final U.S. tax liability on the gain will be less than the FIRPTA withholding tax liability then the IRS may issue a certificate that allows a reduced amount of U.S. tax withholding. The best way to determine the obligation on the sale of the property is a mock return to demonstrate the likely outcome when the return is actually filed.
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