| Law that all Non-US buyers should know about!
All property sales by foreign
nationals are subject to a 10% withholding at closing unless the
seller and the Realtor have planned for this problem. We at Kellett
Realty recommend that all foreign nationals who are buying or selling
property in the USA consult with US tax experts. We can provide you with a
list of registered tax experts who can assist you.
A little planning can save
thousands of dollars, prevent delays and ensure that your closing goes
smoothly.
RE: CHANGES TO
F.I.R.P.T.A.
DATE: NOVEMBER 12, 2003
On August 4, 2003, the Internal
Revenue Service (the “IRS”) issued final regulations, which require changes
in closing procedures for real estate transactions involving foreign
Sellers. When you learn that the Seller (simply by virtue of being a
nonresident) is or may be subject to the provisions of the Foreign
Investment In Real Property Tax Act of 1980 (“FIRPTA”), WE SHOULD
ENCOURAGE OUR CLIENTS TO RETAIN THE SERVICES OF A CERTIFIED PUBLIC
ACCOUNTANT OR TAX ATTORNEY TO REVIEW AND DISCUSS THE APPLICATION AND
POTENTIAL CONSEQUENCES OF FIRPTA TO THEIR PARTICULAR SITUATION.
BACKGROUND
Sale of a U.S. Real Property
Interest (“USRPI”) by a foreign person is subject to FIRPTA. Congress
passed FIRPTA to “level the playing field” so that foreigners would not
profit handsomely and free of tax on U.S. real estate investments while
their counterparts, U.S. citizens and residents, suffered the full brunt of
the tax laws.
A USRPI is broadly defined to
include any direct or indirect right to receive gain in value of U.S. real
estate. Tangible property sold with the real property is also considered a
USRPI. Under the provisions of FIRPTA, when a foreign owner sells a USRPI,
the Buyer MUST withhold ten percent (10%) of the gross sales price at
closing and send the withheld amount to the IRS within twenty (20) days
after the closing. Please note that it is the BUYER who is
responsible for this withholding tax obligation and who is personally liable
for failure to withhold. This is why the closing agent must collect the 10%
withholding tax at closing. This issue is non-negotiable – a buyer or
closing agent cannot risk assuming this tax obligation if there is no
available exception to the withholding requirement!
Non-residents are required to file
a return and pay tax on the gain. The gain is the difference between the
selling price and the seller’s cost basis in the property. The seller’s
cost basis is the original purchase price plus additional items, including,
but not limited to, certain closing costs on the original purchase,
commissions and other sale expenses, plus capital improvements to the
property. Because the actual gain and corresponding tax is not known at the
time of the sale, it was thought that withholding 10% of the sales price
would encourage compliance. Sometimes, the 10% amount withheld under
FIRPTA will exceed the actual tax on gain that will be due when a return is
filed. For example, if the gross sales price of a single family home is
$500,000.00, the closing agent is required to withhold $50,000 and remit
this amount to the IRS. Assuming that the actual tax on the gain is less
than $50,000, the seller would have to file a return to obtain a refund. If
the sale occurred in January of 2003, the seller would have to wait until
January 1, 2004 to file a 2003 income tax return and request a refund. To
avoid this unpleasant and unnecessary situation and to avoid excess
withholding when the required amount exceeds the tax actually due, the
Seller may file an application for a withholding certificate with the IRS prior to closing (Form 8288-B). In the application the Seller
substantiates to the IRS that the actual tax that will be due when a return
is filed is less than the amounts required to be withheld at closing. At
the closing, if the Seller provides the Buyer/closing agent with proof that
the Seller has applied for a withholding certificate, the Buyer/closing
agent is still required to withhold the mandatory 10% of the gross sales
price, but these funds can be kept in the trust account of the closing agent
pending receipt of the IRS approval or denial of the application. The IRS
is supposed to make its determination within ninety (90) days of its receipt
of the application. Of course, if the IRS approves a lesser amount of
withholding, then within 20 days, the closing agent will send the lesser
amount to the IRS and refund the balance directly to the Seller. This is a very important and
advantageous procedure which should be fully considered and utilized by
clients, under the guidance of a certified public accountant or tax
attorney, if at all possible. It is important to note that this is one of
the most important areas of FIRPTA which has been effected by the new
regulations as discussed below.
NEW REGULATIONS
Non-residents have always been
required to obtain a taxpayer identification number (“TIN”) before they can
file a tax return. This is similar to a social security number, but begins
with “9”, and is used to identify the taxpayer. In order to obtain a TIN, a
non-resident has to complete an application (Form W-7) and send the
application to Philadelphia, PA., along with proof of identification, such
as a passport, birth certificate, and/or drivers license. Original or
certified copies of these important documents are required, and it takes on
average, 90 days for the IRS to assign a TIN and return the original
documents.
In the past, it was not necessary
to have a TIN to submit an application for reduced withholding. Under the
new regulations, a foreign person is required to provide a TIN at the
time of filing any return or statement, including an application for
withholding certificate, for the disposition of a USRPI occurring after
November 3, 2003. The IRS has commented that it will not process a
withholding certificate application which does not include the TIN of the
Seller and, if applicable, the foreign Buyer, and will deny such application
or at least deem the application temporarily incomplete without the
inclusion of the TIN’s.
WHAT THIS MEANS TO
AMERICAN REAL ESTATE AGENTS.
Often, foreign owners are unaware
of withholding requirements or the requirement to provide a TIN until
immediately prior to closing, which does not give the client much
opportunity to address the issue. If you represent foreign Buyers, it is a
good time to make them aware of FIRPTA so that they may consult with a
professional to discuss the advisability of filing for a TIN well in advance
of any considerations to sell the property. There is no risk or
jeopardy for the seller to obtain a TIN! If the client is a
Seller, the earlier you identify these issues, the better – certainly at or
before execution of the contract and preferably, upon listing of the
property. The more time our clients have to consider the ramifications of
FIRPTA, the more options they may have available to them. Remember that
withholding under FIRPTA may seriously impact your closing, especially if
the proceeds of sale are marginal. We have had incidents where, because of
FIRPTA, the Seller was required to bring additional cash to closing just to
satisfy the 10% withholding requirement! Please do not make this mistake,
because sometimes, the Seller is not going to be able to make up the
difference and it will jeopardize the closing!
Foreigners are required to file a
tax return to report the sale even if no tax is due. When the sale occurs
during the year may influence the seller’s decision whether or not to file
an application for reduced withholding. For example, assuming the sale is
late in the year, it might not be worth the effort or cost to prepare the
application. But this should be a decision made by the seller only after
consultation with a professional with expertise in this area!
A final consideration is what
happens in the event that a Seller, or foreign Buyer, fails or refuses to
provide their TIN as required by these regulations? If a foreign Buyer
fails to provide a TIN to the Seller in time to allow the Seller to file for
a withholding certificate before closing, the Seller might be damaged. It
is conceivable that a Buyer might use the TIN filing requirement as leverage
to force concessions from a Seller, especially if the Seller had to come up
with extra cash at closing to comply with the FIRPTA withholding
requirement. Similarly, the foreign Buyer may have exposure if the Seller
fails or refuses to timely provide a TIN following closing to avoid
penalties for late remittance of the withheld amount and late filing of Form
8288. The regulations do not provide sanctions for failure to provide a TIN
on a timely basis. In such cases, we may have to consider inserting into
our contract a clause providing a specific representation by a party to
provide a TIN and possible sanctions if a party does not timely provide the
TIN. This is for our clients ultimate protection.
If you believe that you may have a
FIRPTA issue, please Nell Kellett at 305-968-2122. If our client is in need
of professional assistance and does not have an attorney or CPA, we will
recommend the services of, and make arrangements for our clients to speak
directly with, James Barrett, Esq., a tax partner at Baker & McKenzie, or
Monte Gordon, CPA, a tax partner with Berenfeld, Spritzer, Shechter & Sheer,
CPAS, with whom I have worked with both of these gentlemen over the past
few years and they have been very helpful to our agents. Monte’s firm has
been approved by the IRS as a processing agent for TIN applications.
Therefore, if an application is prepared by his firm, it is not necessary
for the applicant to send original identification documents with the W-7
application to the IRS in Philadelphia. Either Monte Gordon or Jim
Barrett will be a great resource to our clients. More importantly, having a
tax professional assist you in these matters will take pressure off we can
focus on servicing our clients through the transaction. The sooner you
identify a potential FIRPTA issue and have it reviewed by a professional,
the more effective you will be. Our clients appreciate our efforts!
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