What Is FIRPTA Withholding?
In the United States, real estate transactions involve a certain level of taxes. In most cases, American citizens who sell their property will have to pay capital gains taxes on their profits. Foreign investors often end up paying some hefty fees, as well. If you are a foreign investor in U.S.-based real estate or stocks that generate income, you might have already heard of the Foreign Investment in Real Property Tax Act or FIRPTA.
What Is FIRPTA Withholding?
The Foreign Investment in Real Property Tax Act (FIRPTA) Withholding is a tax charged by the United States Federal Government to foreign investors who deal in real estate. The government passed the law in 1980 to ensure that all non-resident alien individuals and foreign corporations pay their fair share of US tax on income generated from direct or indirect investments in US real estate.
FIRPTA is an act that requires withholding of 15% tax on each purchase of a US property for foreign investors.
Who Is Responsible for Paying FIRPTA Withholding?
The person responsible for paying FIRPTA withholding is always the one who sells the property. Sometimes, this is the foreign investor; or it's the U.S.-based realtor that represents them and collects and processes their required forms and documents. If you are classified as a foreign individual, the rate of FIRPTA withholding is 15% of the purchase price. Withhold this particular withholding tax when you close on your property deal.
The rate of FIRPTA withholding for a foreign corporation is equal to 21% of the gain. Domestic corporations tax at 15% (10% for dispositions before February 17, 2016) of the foreign seller's gains. If an LLC owns the property in question with a single member, the FIRPTA withholding remains 15%. However, if the LLC has a partnership, the FIRPTA rules do not apply.
When to Apply It?
The law comes into effect when a foreigner invests in real estate (shares, land property, etc.) and the cost exceeds $300K. If this sum is less than $300K, you do not have to pay the withholding tax. This withholding does not apply to foreign investors residing in countries with tax treaties with the USA. For example, Canada and the United Kingdom. These treaties indicate local taxation, and without the need for withholding.
Therefore, the withholding does not apply:
- If you, as a foreign investor in American real estate, apply to exclusion and prove that your country of origin has a tax treaty with the United States.
- You choose to file form W8-BEN (indicating that you will be taxed locally) if your country of origin has a tax treaty with the United States.
Learn more about our Tax Services.
Why Does the State Apply This Tax?
The rationale behind applying FIRPTA withholding law is to ensure that foreign investors contribute their fair share towards tax. An investor who purchases a property in the US must pay 15% withholding on the purchase price and submit Form 8288 (the Foreign Investment Real Property Tax) to both the buyer and seller to avoid the tax. The 8288 form is used to report income from any US source and pay taxes on such income.
The state applies this withholding tax because it serves as a deterrent for foreign investors who might avoid or evade taxes (which is illegal). It also assures the government that investors pay their fair share of tax.
What Happens If I Evade a FIRPTA Withholding?
If you fail to disclose to the state any real estate involved in the US, whether directly or by proxy (e.g., an agent), and perform a transaction without notifying the IRS, you might be charged with perjury. You must also notify the state about any increase in ownership of indebtedness belonging to the seller. This also applies if you are the owner of more than 50% of the buyer or seller.
If your company fails to submit Form 8288 (used to state your income from US sources and pay tax on it), it will be considered an attempt to avoid paying tax, which is illegal. The law also states that if investors fail to report FIRPTA withholding, they may have to pay illegal activities fines of up to $10K, or imprisonment of up to one year.
What Papers Do I Need to Show or Can the IRS Ask Me About?
Throughout the transaction, the state will require you to submit forms. Remember that withholding tax is not a final tax. Report this annually with your annual tax returns.
The forms needed during a FIRPTA withholding transaction include:
- Form 8288, used to report income from any US source and pay taxes on such income.
- Form W-8BEN required any nonresident alien individual or foreign entity to claim beneficial treatment, including reduced withholding under an income tax treaty. It certifies that such person or entity is not a US citizen and establishes residence status in another country.
- Form W-9 is required before an entity can hire a non-resident alien individual who requests a taxpayer identification number (TIN).
- Lastly, you may be asked for a certificate of compliance that certifies that your withholding agent has withheld according to the FIRPTA law.
How Can I Make The Process Of FIRPTA Withholding Successful?
To avoid any complications that may arise from FIRPTA withholding, appoint a professional who specializes in this field. This ensures that your interests are protected throughout the transaction and facilitates an easy transition. A company specializing in FIRPTA withholding may help you avoid fines and imprisonment if your withholding fails. It can also withhold additional taxes for foreign investors. You must understand the FIRPTA withholding tax and know what to expect before dealing with real estate in the US.
How H&CO can help you
FIRPTA withholding applies to all foreign investors who invest in US real estate and is applicable for all purchases of property made by non-resident alien individuals or groups. The federal government imposes FIRPTA withholding tax on both buyer and seller. The tax ensures that all foreign investors contribute their fair share towards tax. This withholding tax is a deterrent to potentially illegal behavior by foreign investors.
When engaging in business dealing involving US property, hire a professional who specializes in FIRPTA withholding. This ensures that you protect your interests and the process remains as easy as possible for you.
