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Understanding FIRPTA Tax Withholding: What You Need to Know

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Foreigners purchasing real estate in the USA.
Buying and selling real estate in the United States can be a complicated and stressful matter. Add to the mix the issue of when an individual engaged in such real estate transactions is a foreign national; the complexity can be even more daunting. This is particularly true when considering the tax implications of such business dealings. For those in this situation, a particular act known as FIRPTA, or the Foreign Investment in Real Property Tax Act, is an important set of laws that should be known. FIRPTA, enacted in 1980, allows the US government to claim tax dollars for certain real estate transactions. The law ensures that foreign persons, as well as foreign corporations, contribute their share to federal tax coffers. Additionally, in 2015 (thirty-five years after the original Act), the PATH Act altered some of these original FIRPTA provisions, including how much of a withholding rate the government could demand.

Who is Affected by FIRPTA Tax Withholding Laws on Foreign Investment?

The law cites “foreign persons” who dispose of “real property” as falling under FIRPTA conditions. For those who do not know the specific definition, a “foreign person” typically includes what are known as nonresident aliens. FIRPTA is designed to tax foreign persons on the disposition of US real property interests, ensuring that they are subject to taxation on profits from such transactions. To explain, a nonresident alien (for this tax discussion) is someone who meets the following criteria: 1)      a person who is not a citizen of the United States, and 2)      a person who neither meets the “substantial presence” nor “green card” tests as specified by the Internal Revenue Service As cited by the agency, to meet the Substantial Presence Test a person needs to be physically in the US for a minimum of:
  1. 31 days during the current year, and
  2. 183 days over a three-year period, which includes:
  • All days an individual was present in the US during the current year, and
  • One-third of the days present in the US during the previous year, and
  • One-sixth of the days present in the US during the second year (and before the current).
As for the Green Card Test, tax regulators consider you a resident (for federal tax purposes), if you are a lawful permanent resident of the country at any given time during the year. Generally speaking, foreign nationals have this status if they were issued a Permanent Resident Card (Green Card) and are living permanently (as an immigrant) in the country. What else falls under the FIRPTA regulations? Any foreign corporation that has not chosen to be considered a “domestic corporation,” as well as any foreign trust, estate, or partnership.

Real Property and FIRPTA

So, what kind of transaction would incur a tax under FIRPTA? We need to think about what is considered “real property.” According to regulations issued by the IRS, having an ownership interest in real property means owning any property such as real estate–a home, land, etc.–situated in the United States or within the US Virgin Islands. This can also include having ownership interests in natural resources, such as mines or resource-producing wells. Additionally, the term can include things that are connected to the use of real property, like equipment used for farming practices. What else? The term real property can also mean any type of ownership of a corporation or part of a corporation (again, domestically based). This can be a complicated classification and may have additional criteria which affect its determination under the law. Specifically, a domestic corporation may be considered a US real property holding corporation if it meets certain criteria related to the value and nature of its real property interests over specified periods. It is best to be determined by obtaining counsel from appropriate tax service professionals.

FIRPTA Tax Withholding Rates and Timeline

There are several tax rates to consider when discussing FIRPTA. For instance, when a person sells their interest in a real property within the United States, they may be required to pay 15% of the overall sale price (if above $1 million) to the IRS. For properties that sell for less than this $1 million mark (but more than $300K), the withholding tax rate drops to 10%. When a property sells below the $300K point, the seller is not responsible for any tax. Finally, if a property seller (again, who is not a citizen of the United States) files a return with the IRS and shows that no capital gains tax is due from the overall return, the Service may issue the seller a refund. As for foreign corporations, they must withhold a tax equal to 21% of any recognized gain when distributing US real property interests to foreign shareholders. This highlights the importance of understanding withholding obligations and the specific tax rates tied to certain property transactions. Interestingly, FIRPTA demands that the buyer of real property within the US from a seller who is a foreign national be the one who withholds 15% of the total cash paid. What is important to note is that this dollar number does not consider whether the seller of the property made (or lost) money on the sale. Rather, the tax withheld is based on the transaction’s value. The fair market value of the property also affects the withholding amount, ensuring compliance with tax regulations. So, in essence, this first step in the withholding process serves as a preliminary tax collection. The final and actual tax owed by the seller will be determined later once they file a federal tax return. In that return, they will report on the real property sale and note any gains or losses by comparing it to the original purchase price. The property’s adjusted cost basis (purchase price plus considering any property improvement expenses) will affect the amount held under FIRPTA. It is after this point that the seller of the real property can then apply for a refund of any monetary difference. (Obviously, once the return is complete and more tax is due, the seller instead will be obligated to pay any additional taxes.) A withholding certificate can be requested to potentially reduce the withholding amount that buyers must withhold at closing. This certificate is an application for a lower withholding dollar amount as it is based on the capital gains of the property sale rather than on the overall sale price of the property. When it comes to reporting and paying any FIRPTA withholding obligation, time is of the essence. All necessary tax forms and taxes due are to be sent to the IRS within 20 days after the disposition date of the property. Literally, just under three weeks after a purchase of real property in the United States from a foreign person or corporation, all forms, and payments withheld and reporting to the IRS must be completed.

Income Tax Withholding Requirements: Who is the Withholding Agent Responsible?

As mentioned above, the responsibility for FIRPTA withholding rests primarily with the buyer of the property. Thus, the buyer must determine whether the seller is a foreign individual and, therefore, subject to FIRPTA withholding. If the buyer fails to perform this withholding when required, they can be held liable for taxes due. The buyer must withhold tax from the sale to ensure compliance with US tax laws. This will likely come as a surprise to those who buy real estate or some other “real property” within the United States from a foreign national. Why? Because typically US sellers of property are the ones who are responsible for withholding and remitting taxes to the Internal Revenue Service. They are the ones responsible for reporting and paying on their gains. That said, when the seller of the property is foreign, the situation is reversed due to FIRPTA regulations. Again, it is the responsibility of the buyer to withhold the money for tax obligations. Take the example of Maria Alcaraz, a citizen of Spain, who owns a vacation home on Key Biscayne, an island off the coast of Miami, Florida. Purchased in 2009 for the tidy sum of $269,000 during the financial crisis due to the housing market downturn in the US. Fast forward to 2023, Alcaraz decides it’s time to sell the property and invest her money elsewhere within the state. After finding a buyer, (US resident Jonathan Joyner), she agrees to sell the home for $450,000, for a nice profit of $181,000. Under FIRPTA requirements, Joyner (the buyer) becomes what is known as a “withholding agent” and is required to retain 15% of the sale price, or in this situation, $67,500, as the amount to be delivered to IRS as a tax withholding. In addition, Alcaraz is responsible for filing a return in the US so that federal tax authorities are aware of the property sale. That said, it may be possible for her to get back a portion of this tax withheld if her overall tax responsibility is less than the amount originally committed. Regardless, FIRPTA ensures that the IRS gets its money upfront.

FIRPTA and Real Property Tax Act Exceptions

While the regulations that come from FIRPTA cover a broad range of financial transactions, there are indeed exceptions that can be based on provisions found within treaties between the United States and other countries from which nationals involved in the transactions hail. For instance, due to such treaties, a lesser tax withholding rate compared to the above-mentioned 15% may be applicable. Important to note is that some treaties are created with the intention to prevent or at least reduce tax evasion, as well as also to help foreigners involved in a US transaction avoid being double taxed. Again, as FIRPTA tax obligations are a tricky part of the US Internal Revenue Code to navigate, working with experienced tax professionals can be more than useful.

Compliance and Penalties

Taxes owed due to the FIRPTA regulations are a complicated matter. This Act provides the US government with the authority to ensure that compliance by investors in real estate and other real property is adhered to. Like any tax reporting and tax payment obligations, noncompliance with such the laws contained in FIRPTA is risky. It is vital that the parties involved in such transactions – buyers and sellers alike – know and comply with these laws or else face severe penalties. These can include the recovery of withholding amounts, interest accrued, and even additional fines and penalties.  

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