At the end of 2015, new provisions that resulted in significant changes to the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) rules regarding federal income taxes for foreign investors owning United State real estate became law. The most significant provision impacting real estate transactions involving foreign participants or non-resident aliens include increasing the FIRPTA withholding tax rate from 10% to 15% effective for dispositions after February 17, 2016. However, sellers could be exempt from withholding tax under the following three conditions:
- Property to become buyers’ personal residence with sales price not exceeding $300,000
- Transactions in which the IRS has issued a withholding certificate to the foreign seller
- Seller declaration of non-recognition of gain or loss. The second exception to the FIRPTA withholding requirements is in the case of a simultaneous 1031 exchange and the transferee is not required to withhold if the “[t]he transferor gives written notice that no recognition of any gain or loss on the transfer is required because of a non-recognition provision in the Internal Revenue Code or a provision in a U.S. tax treaty.” Such a notice is called a “Declaration and Notice to Complete an Exchange” (“1031 Declaration and Notice”). A transferee can rely on a 1031 Declaration and Notice only if: (1) the foreign person completes a simultaneous exchange (i.e., the same day), and (2) the foreign person receives no cash or mortgage boot.
Under the foregoing rules, a buyer of U.S. property from a foreign person can rely on a 1031 Declaration and Notice only if the foreign person exchanges U.S. property for other U.S. property in a swap in which the foreign person receives no cash or mortgage boot. Since many exchanges can involve payment of some cash or debt reduction, the utility of a 1031 Withholding Certificate is substantially reduced. Impact on Delayed Exchanges To the extent that the 1031 exchange is not simultaneous, or if any cash or mortgage boot will be received by a foreign person with respect to the disposition of U.S. property, the buyer can only rely on a Withholding Certificate issued by the IRS to a foreign person. As a result, foreign persons desiring to engage in a delayed 1031 exchange should consult with a tax advisor and apply for an International Tax Identification Number (ITIN) and a 1031 Withholding Certificate well in advance of the anticipated disposition of U.S. property holdings.