FIRPTA Changes Affect Taxes for Foreign Investors in U.S. Real Property
Overseas residents have had great success investing in U.S. real property. Some buy personal vacation homes in our beautiful cities; others own limited liability companies or stock in a U.S. corporation whose underlying assets consist of U.S real property. Whatever form these foreign investments take, hefty taxes can arise with the eventual disposition of the property or interest in the entity holding the property, and many investors are unaware of the intricate web of requirements that unfolds with these transactions.
If you’re involved with these investments or the disposition (usually by sale) of the real property, you should get up to speed on the Foreign Investment in Real Property Tax Act (FIRPTA) and the recent legislative changes affecting it.
FIRPTA was designed to level the playing field for domestic investors. Prior to its enactment, foreign investors had an unfair advantage when investing in U.S. real estate if the transaction was structured through a corporation, and the stock in that corporation — rather than the underlying real estate — was later sold or otherwise disposed of. The sale of the stock, which is a capital asset, had generally been sourced outside the U.S. taxing net for foreign investors. FIRTPA widened the net so stock transactions no longer escape tax-free.
FIRPTA issues arise for foreign investors when they dispose of a U.S. real property interest (USPRI). A USRPI is a direct ownership interest in real property located in the United States or the Virgin Islands. Real property includes land and its un-severed natural products and improvements, as well as personal property associated with the use of real property.
A USRPI can also be an interest in a partnership meeting certain ownership tests, or it can be an interest in a domestic corporation that has been a U.S. real property holding corporation at any time within the five-year period prior to the disposition date, if the fair market value of its real property assets exceeds 50 percent of the total of certain specified assets. It’s clearly rather complicated.
FIRTPA makes the purchaser the withholding agent
When a foreign individual sells a USRPI, he or she must report the gain or loss on his or her individual U.S. tax return and pay the taxes due.
But the purchaser of the USRPI has obligations, too: The purchaser must withhold a tax equal to 10 or 15 percent (whichever is applicable) of the gross sale price and remit the withholding tax to the IRS. When the seller files his or her U.S. income tax return to report and pay tax on the net gain, a credit is given for the amount of FIRPTA withholding toward the total tax due.
Recent legislative changes
The Protecting Americans from Tax Hikes Act (PATH) was signed in December 2015 and includes FIRPTA changes, most notably an increase in the withholding rate (see above) from 10 to 15 percent on the gross sales price on most transactions. This increase doesn’t apply to the sale of a personal residence with a price tag less than $1 million.
Some additional PATH modifications to FIRPTA include:
- Exemption for gains from the sale of stock of a publicly traded real estate investment trust for those shareholders that own 10 percent or less of the publicly traded stock. The 10 percent ownership requirement is an increase from the previous 5 percent.
- Exemption of any U.S. real property interest held by a foreign pension fund from FIRPTA withholding, which now puts foreign pension funds on the same footing as U.S. pension funds.
Exceptions to FIRPTA withholding
While most dispositions of a USRPI are subject to FIRPTA withholding, there are some exceptions:
- Applying for a reduced rate of withholding can provide a time-value-of-money savings related to the reduced withholding. Because the FIRPTA withholding is calculated on the gross sales price, it often results in an over withholding of the ultimate total tax due on the net gain. Sellers of USRPI may apply with the IRS for a reduced amount of FIRPTA withholding prior to the disposition of the USRPI. A reduced withholding amount may be established by certifying that the seller has loss carryforwards that will offset the net gain, or by establishing that tax on the net gain will be less than required withholding based on the gross sale price.
- If the property sold is used as a personal residence, and the amount realized is not more than $300,000, withholding is not required — with conditions. The purchaser (an individual only) or a member of his or her family must have definite plans to reside at the property for at least 50 percent of the time the property is in use for every 12-month period after the transfer date.
- There are also many scenarios that require reporting and filing statements to rebut the presumption that there is a disposition of a USRPI or FIRPTA does not apply because an IRS non-recognition provision.
How we can help
Because U.S. real estate is a large part of foreign direct investment, FIRPTA issues can be a trap for the unwary. Foreign investors in U.S. real estate can easily overlook the various FIRPTA withholding requirements or options to reduce the withholding when selling a USRPI.
CLA’s international tax professionals can assist you with structuring your initial investment to help minimize the U.S. income tax consequences and analyzing the FIRPTA impact when a U.S. real property interest is sold.