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Withholding Requirements on Foreign Sellers

With the increase in foreign purchases of real estate comes the eventual sale of that real estate. Nonresident aliens (foreign persons), selling real estate in this county, need to be aware of "FIRPTA" and its withholding requirements.

When a nonresident alien (or a foreign corporation, foreign partnership, foreign trust, or foreign estate), sells real property located in the United States, that person (or entity), is required to have ten (10%) percent of the gross sales price withheld from the proceeds disbursed at closing. The Foreign Investment in Real Property Tax Act ("FIRPTA"), requires that the 10% withholding be paid in to the Internal Revenue Service ("IRS") within twenty (20) days of the closing. 

The 10% withholding is to be used toward a seller's tax liability, should there be any. Whether or not a seller actually owes any tax will depend on each seller's unique tax circumstances - a seller may owe nothing, or the 10% may not cover what the seller owes - it all "depends". It is simply a deposit that is applied toward the actual tax. 

Foreign sellers are required to file a U.S. income tax return to report the sale and determine the amount of the actual tax that is due, or, the amount to be refunded if the tax is less than the amount withheld and paid in to the IRS. In the event the actual tax due is more than the amount withheld and paid in, the seller is liable for the difference and the balance due must be paid to the IRS. 

However, there does exist one very specific exception to the general withholding rule.  In the event the sale price is not more than $300,000 AND the buyer acquires the property for use as a home, AND the buyer or a member of the buyer's family has definite plans to reside at the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the date of closing, no withholding is required. When counting the number of days the property is used, do not count the days the property will be vacant. This exception is not available for vacant land, and the buyer must be an individual, not a corporation, limited liability company, partnership, estate, or trust.

If this exception is to be utilized, the buyer will be required to sign an affidavit under oath affirming that the conditions of the exemption will be met. If the buyer does not fulfill the conditions, the buyer can be liable to the IRS for the tax.  The exemption does not exempt the seller from liability for any tax that may be due, it simply alleviates the necessity of collecting the 10% at closing and paying it in to the IRS. Whether the buyer signs the required affidavit or not has no impact on the amount of the seller's tax liability; even if the exemption is utilized, the seller is still obligated to file a US income tax return on the sale. The seller's unique tax circumstances will determine whether or not any tax is owed.

For transactions where the sale price exceeds $300,000, no exemption from withholding exists; no if's and's or but's about it.  Withholding is required for any sale that exceeds $300,000; this is the case whether or not the sale results in a profit or a loss.

If a seller suspects that the actual tax on the sale will be substantially less than the amount of the 10% withholding, a seller may apply for a withholding certificate from the IRS.  A withholding certificate permits withholding an amount less than 10%.  In such a case a seller may choose to file an application with the IRS demonstrating that the sale will result in a loss (or a tax less than 10% of the sale price). However, the problem with this alternative is that it generally takes the IRS ninety (90) days, or more, to issue a withholding certificate. 

The decision to apply for a withholding certificate, or not, will depend on the unique circumstances of each sale, taking into account the likelihood that the actual tax amount might be less than the withholding amount, the amount of time needed to obtain the certificate, and the amount of time a refund might take to be received after an income tax return is filed (depending on the time of the year, a seller might have to wait until the following January to file an income tax return).

Please note, that in the case of a short sale, where the proceeds of a sale will not be insufficient to pay the outstanding mortgage in full, the 10% withholding rule nevertheless still applies. As a practical matter, the only real alternative is to apply for a withholding certificate. It is not likely that a mortgage holder would approve a short sale with a 10% withholding - that is an amount the lender would be further conceding from its short payoff. 

Since every situation is unique, it is important to seek advice from a tax professional as to the most reliable method of complying with the FIRPTA requirements where the property to be sold is owned by a nonresident alien.

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