IRS Forces Buyers To Pay Foreign Seller's Taxes?! Demystifying FIRPTA, both California and federal
Updated: Oct 5
If you buy a home from a seller who is a foreign person, you could be 100% responsible for the seller's taxable withholding, including interest and penalties.
Are you a U.S. citizen and looking to buy a home from a foreigner?
Are you a Foreigner and need to know about U.S. FIRPTA withholding laws?
Are you an individual who is looking to buy a property in the U.S. but you are a foreigner?
Then this article is for you.
Table of Contents
How can the Federal government tax a buyer?
When the seller of real property (residential and commercial) is a foreign person, then under the federal law passed in 1980 called Foreign Investment in Real Property Act of 1980 (FIRPTA), a buyer of real estate is obligated to send to the IRS the taxable withholding based on the below table:
How much tax to withhold for the seller in California?
California law requires a buyer to send the withholding to the Franchise Tax Board as a “prepayment” of the state tax a seller owes on the sale of real estate.
The seller can choose between the traditional withholding equal to 3.33% of the sales price, or withholding based upon computing the amount of tax that would be due on the actual gain using the maximum tax rate.
The Franchise Tax Board has forms and tools on its Web site to help investors compute the amount of tax due. The law requires that the Franchise Tax Board forms notify investors that title, escrow and exchange personnel are not allowed to give investors legal or accounting advice about the amount of the withholding. For this reason and because the certification must be done on or before the closing, investors are urged to discuss this issue with their tax advisors well before the sale of real property.
Are there FIRPTA withholding exemptions?
Yes! Click here for the full list.
Are there California exemptions?
No withholding is required upon:
The sale of a principal residence or if the seller is a partnership or is a corporation that is either formed in California, qualified to do business in California, or has a permanent place of business in California.
In addition, if the investor completes a 1031 exchange, withholding is only due on the boot, and only if the boot exceeds $1,500.
What penalties will be issued to the buyer if they fail to withhold?
A buyer who fails to withhold may be liable for the entire amount of the tax, plus interest and penalties, if the seller is a foreign person and does not pay taxes on the sale.
NOTE - The buyer cannot appoint the Escrow or Title Company as the withholding agent but what typically happens is that the Title/Escrow company will submit the withholding to the IRS via escrow once buyer and seller agree on the amount.
Who is a foreign person?
A Foreign Person is a nonresident alien individual or foreign corporation that has not made an election under section 897(i) of the Internal Revenue Code to be treated as a domestic corporation, foreign partnership, foreign trust, or foreign estate. It does not include a resident alien individual.
Who is a resident alien?
An alien is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.
NOTE: If you are a nonresident alien at the end of the tax year, and your spouse is a resident alien, your spouse can choose to treat you as a U.S. resident alien for tax purposes and file Form 1040 using the filing status “Married Filing Jointly.”
What IRS forms are required?
The following forms should be provided before closing by both seller and buyer. (We recommend using a FIRPTA specialist to help fill these out.)
Form 8288A (Copies A & B)
Form 8821 (from EACH buyer and EACH seller)
How we, as your realtor, help you avoid FIRPTA issues?
When we represent you as our buyer, we take into consideration the residency status of the seller in order to determine if FIRPTA applies. How? By reviewing the following disclosures...
California Association of Realtors (CAR) form AS
Certification of Non-Foreign Status
Also, we as your agent use the standard CAR Purchase Agreement. This document contains section 11H that specifies that the escrow company is to withhold the required taxes.
In addition, we also ask the seller to cover the buyer’s costs related to the tax filing & withholding (such as tax advisor fees). This amount can be placed into escrow with the title company until closing, or a check can be cut at closing to be submitted with the IRS filings. In cases where the seller did not disclose their foreign residency or entity status up-front, we may request additional funds from the seller to account for your FIRPTA obligations and expenses as our buyers.
When the seller is a foreign person, we recommend that our buyers have their lawyer or tax advisor assist with preparing the above IRS forms as well.
When we represent the seller, we ensure our seller’s foreign residency is disclosed in their listing and in the special agreements section of the contract. We may suggest offering to cover the buyer’s costs relating to filing the IRS forms and withholding as part of our negotiations. As a best practice, we recommend all of our foreign person sellers retain a CPA and file Form 8288-B prior to closing. This can be provided to the buyer to help reduce or even eliminate issues.
FAQs regarding FIRPTA withholdings
There are many more examples on the IRS website, but here are a few we thought the most applicable.
Question 1: If a U.S. real property interest (USRPI) is jointly owned by spouses, one foreign person and one U.S. person, and the USRPI is disposed of, may the spouse who is a U.S. person report 100% of the amount realized from the disposition and the spouse who is a foreign person report 0% of the amount realized to avoid the withholding required under Internal Revenue Code section (IRC) 1445?
Answer 1: No, the amount realized cannot be allocated entirely to one transferor when two or more transferors own the USRPI.
If one or more foreign persons and one or more U.S. persons jointly dispose a USRPI, the amount subject to withholding under IRC 1445 is determined in the following manner:
The amount realized is allocated among the transferors based on their capital contributions to the USRPI. For this purpose, a husband and wife are treated as having contributed 50% each.
The transferee/buyer withholds on the total amount allocated to foreign transferor(s).
The amount of credit for the withholding to be allocated to each foreign transferor is allocated in accordance with the foreign transferors’ agreement. The foreign transferors must request that the withholding be credited as agreed upon by the 10th day after the date of transfer. If no agreement is reached, the transferee will credit the withholding by evenly dividing it among the foreign transferors.
Question 2: In the situation where a U.S. real property interest (USRPI) held in the name of a grantor trust is disposed of and the grantors are a married couple, one U.S. person and one Foreign person, is withholding under IRC 1445 required?
Answer 2: Yes, withholding under IRC 1445 is applicable in situations where a USRPI held in the corpus of a grantor trust is disposed of when a Foreign person is considered a grantor with respect to all or a part of the USRPI. Based on the grantor trust rules (IRC 671 through IRC 678), an individual is the grantor of the asset(s) he or she contributes to the corpus of a trust that he or she is determined to still have control over under the grantor trust rules.
For example, if a USRPI is purchased equally by a husband, who is a U.S. person, and wife, who is a Foreign person, in their names and then contributed to the corpus of a trust. After the contribution, the husband and wife are determined to still have control over the USRPI under the grantor trust rules. Then the husband and wife are considered grantors, each owning 50% of the USRPI. So, for the purposes of IRC 1445, when the USRPI is disposed of, withholding would be applicable to the foreign spouse’s 50% of the sales proceeds.
Additionally, if a USPRI is purchased in the trust’s name from monies contributed to the trust in equal amounts by both the husband and wife (one U.S. person and one foreign person) and both spouses are considered to be grantors of the monies contributed to the trust used to purchase the USRPI, then both spouses are grantors of the USPRI once it is purchased. In the case, for purposes of IRC 1445, when the USRPI is disposed of, withholding would be applicable to the foreign person’s 50% of the sales proceeds.
Answer 5: The exclusion of gain for the sale of a personal residence under IRC 121 may apply to NRAs when they sell their U.S. personal residence. Because NRAs cannot file joint returns unless they are married to U.S. persons, NRAs would need to take their own share of the principal residence exclusion amount on separate tax returns. Consequently, the maximum amount of excludable gain for NRAs that file Form 1040NR, U.S. Nonresident Alien, is $250,000. For the exclusion to apply, NRAs would have to meet the eligibility test required for the exclusion. To determine if a nonresident alien meets the Eligibility Test, you can review the five steps of the Eligibility Test in Publication 523, Selling Your Home, as well as review Topic No. 701, Sale of Your Home.
If an NRA qualifies to claim the IRC 121 exclusion, the statutory withholding under IRC 1445 on the amount realized from the sale could exceed the maximum tax liability on the sale. Therefore, an NRA may request a withholding certificate from the Internal Revenue Service to provide to the buyer. The withholding certificate would allow the buyer (through escrow/closing agent) to withhold tax at an approved reduced rate.
Specific details and procedures may vary, so it's essential to consult with tax professionals or legal experts for precise guidance regarding FIRPTA and withholding in California.
As your trusted realtor for both buying and selling homes, we are well versed in FIRPTA related homes and are here to help guide you through this process anytime.
Feel free to call Kevin (650.451.8763) anytime and sign up for our newsletter for more tips when it comes to buying or selling real estate in the SF Bay Area / Silicon Valley / California.