Starting Feb. 16, 2016, settlement agents must begin retaining additional proceeds from the sale of property by foreign nationals thanks to recent changes to the Foreign Investment in Real Property Tax Act (FIRPTA). The changes were part of the year-end tax extension legislation signed into law by President Obama on Dec. 18, 2015. The bill reference is H. R. 2029, now known as Pub. L. No. 114-113.
FIRPTA is a tax law passed in 1981 that requires foreign persons to pay U.S. income tax on the gains they make from selling U.S. real estate. The responsibility is on the U.S. national buyer (not the settlement agent) to deduct and withhold a portion of the amount realized (generally the sales price) and report the sale to the Internal Revenue Service (IRS). Buyers can withhold less than the statutory amount if they obtain a determination of the specific amount of tax owed by the foreign national using IRS Form 8288-B. In most cases, the settlement agent is the party that actually remits the funds to the IRS, but the buyer is held legally responsible. Additionally, until the tax is paid in full, the government obtains a security interest in the real property.
Prior to February 16, 2016, the withholding amount was 10% if the sales price was $300,000 or more. The 10% rate will still apply for those transactions in which the property is to be used by the buyer as a residence, provided the amount realized does not exceed $1 million, and the existing $300,000 “exemption” remains unaffected. But what does it mean to be used by the buyer as a residence?
The instructions for filling out the IRS Form 8288 have been updated to clarify that the same factors that qualify a transaction of $300,000 or less to be exempt from withholding will be the same factors that qualify a transaction of $1,000,000 or less for the reduced withholding rate of 10%. So the definition of “used by the transferee as a residence” for purposes of the exemption if the sale is $300,000 or less should be used to determine whether the reduction of the withholding rate from 15% to 10% applies. In this context, “residence” means occupied by the buyer or a member of his family at least fifty percent of the time in which it is occupied for the first two years. It should also be noted that the buyer needs to be one or more individuals.
Here are the new guideline under the recent FIRPTA changes:
- If the amount realized is $300,000 or less, AND the property will be used by the buyer as a residence, the withholding rate is zero percent.
- If the amount realized exceeds $300,000 but does not exceed $1 million, AND the property will be used by the buyer as a residence, the withholding rate is 10% on the full amount realized.
- If the amount realized exceeds $1 million, then the withholding rate is 15% on the entire amount realized, regardless of use by the buyer.
- If the property will not be used by the buyer as a residence, then the withholding rate is 15% on the full amount realized.
- If the buyer is not an individual (one or more) then the rate is 15%.
It is recommended that settlement agents document the buyer’s intent to use the property as a residence as best they can and point out to the buyer the risks of allowing the exemption to apply to their transaction. Under the law, the buyer is the withholding agent and is responsible for withholding and remitting the proper amount to the IRS. Settlement agents should also be vigilant for situations where the foreign Seller forces the Buyer to claim residence status merely to lower the withholding rate, since the buyer could be liable for any additional withholding tax, penalty, and interest if their intent is ever challenged by the IRS.
These changes have prompted revisions to the current FR/BAR contract to change the withholding amount.