FIRPTA and the First Day Effect

Island bayouThe days of our lives are scattered with those first times we always remember – a new school, a new job, a new year, a new romance – those milestones that come and go, and in the lead-up can be the impetus for a new way of doing things, different from how we approached or looked at life before.

Thanks to an impending rule change by the Internal Revenue Service (IRS), on February 17, 2016 the rate of income tax withholding in connection with the disposition of a U.S. real property interest to which a foreign person is subject increases to fifteen percent (15%) of the amount realized by the Seller on the transfer, from the present ten percent (10%) level.

Under the rules of the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), it is the buyer of real property who is required to withhold the percentage due on the transfer, and remit the withheld amount to the IRS (I) unless an exemption applies, or (ii) the seller has obtained a Withholding Certificate from the IRS authorizing a reduced amount of withholding.

According to noted international tax specialist Renea Glendinning, CPA, “If the buyer fails to withhold the proper amount, they can be held liable for the withholding.  The buyer’s closing agent generally acts on the buyer’s behalf to assist with meeting any withholding obligations.”

Up to now, most buyers were nonchalant about the withholding obligation, and happy to accommodate foreign sellers when it came to allowing them to await receipt of a Withholding Certificate, rather than forcing remittance of the withheld funds at the time of closing.

With the withholding rates going up (and the potential liability getting larger), the rush to the new era seems to have bred a newfound lack of willingness to accommodate foreign sellers in their acquisition of a Withholding Certificate. In the run-up to the rate change, buyers have begun to exercise their rights under a formerly obscure FAR/BAR contract provision to force the remittance at the time of closing, which states in part:

“If prior to Closing Seller has submitted a completed application to the IRS for a Withholding Certificate and has provided to Buyer the [required] notice…but no Withholding Certificate has been received as of Closing, Buyer shall, at Closing, withhold [15%] of the amount realized by Seller on the transfer and, at Buyer’s option, either (a) timely remit the withheld funds to the IRS or (b) place the funds in escrow, at Seller’s expense, with an escrow agent selected by Buyer and pursuant to terms negotiated by the parties, to be subsequently disbursed in accordance with the Withholding Certificate issued by the IRS or remitted directly to the IRS if the Seller’s application is rejected or upon terms set forth in the escrow agreement.”

From a listing agent’s perspective, an unyielding buyer isn’t necessarily a problem or cause for concern, especially from a timing perspective.   A foreign seller does not have to wait until the following calendar year to file their final tax return and obtain any refund due.  Instead, they can make what is referred to as an application for early refund, which is essentially the same application as the one for the reduced withholding.

The difference in this case is the withholding has to have been remitted to the IRS, and the application must include with it copies of the Form 8288-A to document that the withholding has been paid (therefore the reason it cannot be sent until after closing occurs).  The processing is basically the same as with the application for reduced withholding, but when the Withholding Certificate is issued, the refund is obtained from the IRS, rather than from the closing agent for the sale transaction.  Between not being able to send the application in before closing, and having to get the refund from the IRS, it is likely that only an extra month or two has been added to the time the refund is received.

From a selling agent’s perspective, the issue is more nuanced, and the response to the foreign seller wishing to apply for reduced withholding and escrow funds at closing (rather than remit them to the IRS), can depend in large part on how well the buyer is educated on the subject as the contract is first being written.

Especially given the FAR/BAR form’s statement that “[d]ue to the complexity and potential risks of FIRPTA, Buyer and Seller should seek legal and tax advice regarding compliance,” there is never a better time to get an experienced real estate attorney involved than at the beginning of the transaction to advise on the meaning and implications of the buyer’s withholding obligations and options, and help you forge a consensus for the parties as they move forward to closing.

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This information in this site is not intended to establish an attorney-client relationship, and if anything herein could be construed as legal guidance or advice, I strongly encourage you to consult with your own attorney before relying upon any such information.

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** Publisher’s note: This post was composed with the valuable assistance of Renea Glendinning, CPA (Kerkering Barberio).