Tag: foreign withholding

Real Estate Trends – Foreign Sellers

Foreign Capital and U.S. Real Estate

Understand FIRPTA withholding rules There have been continued international capital inflows into U.S. real estate assets and the trend is expected to grow. Political uncertainty and global economic factors continue to drive foreign money into the United States, long considered a safe haven.

The U.S. property market is the most stable, transparent in the world, making it an easy investment choice. According to research firm Real Capital Analytics, foreign purchases of U.S. real estate assets rose to $62 billion over the 12-month period ending in October 2015.

It should be expected that these foreign investors will eventually reposition their assets and liquidate certain holdings based upon expected returns and market changes.

Understand the Foreign Withholding Rules

Buyers of real estate from foreign sellers, escrow agents and closing agents who close on such transactions need to be aware of the federal withholding requirements set in the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).

Under FIRPTA, the buyer of U.S. real estate from a foreign person or entity must withhold tax equal to 10% of the “amount realized” from the sale. The amount realized includes the total amount received for the property including cash, the existing balance of mortgages encumbering the property, and any non-cash personal property.

Withholding under FIRPTA

Withholding is required when the seller is a foreign person (including non-resident alien individuals, partnerships, trusts and estates, and certain corporations domiciled outside of the United States). At or before the closing, if the seller signs a certification of non-foreign status stating under penalty of perjury that he is not a foreign person, the buyer can rely on that unless he has actual knowledge that it is not accurate. If the seller is able to sign the certification, no withholding is required, but the buyer must retain the certification for five years after the transfer.

If the seller is a foreign entity or person, the buyer must withhold the 10% and remit the tax to the IRS within 20 days of the date of closing. If the buyer fails to do so, the buyer is liable to the IRS for the tax that should have been withheld, plus penalties and interest.

Reduced Withholding

If the ultimate tax liability is expected to be zero or less than the required 10% withholding amount, the foreign seller can apply for a withholding certificate to request a reduction in the withholding amount. This is done by filing IRS Form 8288-B.

There are exceptions to the withholding requirements, including property used as a home and 1031 exchanges, but both are not without specific qualifications.

When purchasing real estate from a foreign seller, it is important for buyers to consult with their advisors to ensure compliance under FIRPTA.

At KRS CPAs, our team supporting commercial real estate is knowledgeable about FIRPTA rules and can assist you. Contact me at [email protected] or 201.655.7411.

Foreign Withholding of Income Tax on Real Estate Transactions

Whether a person is considered a “U.S. person” or “non-U.S. person” will determine which income is subject to federal income tax. This also determines withholdings on that income, which may include earnings from real estate trade/business, passive rental income or sale of property.

Basic Rules

Foreign WithholdingNon-U.S. persons are subject to income tax only on their U.S. source income (income earned within the United States). According to the Internal Revenue Service, most types of U.S. source income paid to a foreign person are subject to a withholding tax of 30 percent, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty.

What’s a U.S. or Non-U.S. Person?  A U.S. person includes citizens and residents of the United States. For income tax purposes, U.S. residents include green card holders or other lawful permanent residents who are present in the United States. A person is also a U.S. resident if he has a “substantial presence” in the States.

A non-U.S. /foreign person, or nonresident alien (NRA) includes (but is not limited to) a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, a foreign estate, and any other person that is not a U.S. person. You can read more on these definitions here.

Withholdings on real estate ventures

If you are a non-U.S. person it is important to consult with tax and/or legal counsel to determine if you are subject to withholding. Below are several situations that could require U.S. withholding with respect to real estate.

  • Trade or business – A non-U.S. person is considered to be engaged in a U.S. trade of business if they regularly undertake activities such as developing, operating and managing real estate. If this is the case, the income is not subject to withholding; rather, the non-U.S. person files an income tax return and computes their applicable tax.
  • Passive rental income – Income from a rental property is typically considered passive income (refer to my previous blog on Passive Activity Losses for details). Rental income is subject to a 30 percent withholding tax unless it is reduced under an income tax treaty. The 30 percent withholding rate is applied to the gross rents and is reported on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding.
  • Sale of property – The Foreign Investment in Real Property Act (FIRPTA) requires a FIRPTA withholding tax of 10 percent of the amount realized on the disposition of all U.S. real property interests by a foreign person. A purchaser of U.S. real property interest from a foreign investor is considered the transferee and also the withholding agent. The transferee must find out if the transferor is a foreign person. If the transferor is a foreign (non-U.S.) person and the transferee fails to withhold, the buyer may be held liable for the tax.

Withholding on foreign partners in a partnership

In addition to filing an annual partnership tax return (Form 1065), if a partnership has taxable income that is effectively connected with a U.S. trade or business, it is required to withhold on income that is allocated to its foreign partners.

The withholding rate for effectively connected income that is allocable to foreign partners is 39.6 percent for non-corporate foreign partners and 35 percent for corporate foreign partners (2016 withholding rates). There are tax treaties with many countries that can reduce the withholding requirements and these should be reviewed.

Note that withholding is calculated on taxable income, not distributions of cash. A partnership needs to be aware before distributing cash to foreign partners that there may be a withholding obligation.

Are you a non-U.S. person with real estate interests in the United States? Or, are you a U.S. citizen or resident working or investing in real estate? I can answer your questions regarding tax issues around passive income losses and other real estate financial considerations; contact me at [email protected] or (201) 655-7411.