FIRPTA Withholding and 1031 Exchanges

Understanding FIRPTA: Foreign Investment in U.S. Real Estate

The Foreign Investment in Real Property Transfer Act (IRC §1445 & Treasury Regulations §1.1445), commonly referred to as “FIRPTA,” is a federal law that imposes withholding requirements on certain real estate dispositions involving foreign persons. Let’s explore the key provisions of FIRPTA, including its exceptions.

Definition of “Foreign Persons” under FIRPTA

FIRPTA applies to individuals and entities that qualify as “foreign persons,” which includes nonresident alien individuals, foreign corporations without a valid election under section 897(i) to be treated as domestic corporations, foreign partnerships, foreign trusts, and foreign estates.

Withholding Requirement on U.S. Real Estate Dispositions

When a foreign person sells U.S. real estate, the buyer (transferee) or withholding agent (escrow officer, title company, or closing attorney) is required to withhold a specific percentage of the sale price and submit it to the IRS. The standard withholding rate is 15% of the sale price, while for personal residences with a sale price of $1 million or less, the rate is reduced to 10%.

Exceptions to Withholding Requirements

FIRPTA provides certain exceptions to the withholding requirement for foreign persons. These exceptions include:

(1) Sale Price Less Than $300,000: If the sales price of the U.S. real estate is less than $300,000, and the transferee intends to use the property as their personal residence, no withholding is required.

(2) Withholding Certificate: Foreign persons can apply for a Withholding Certificate (IRS Form 8288-B) from the IRS. If approved, the Withholding Certificate allows for a delay, reduction, or elimination of the withholding amount. The application must be submitted to the IRS on or before the closing of the Relinquished Property. If the IRS approves the application, the withholding agent can hold the withheld amount until the IRS reaches a final determination, typically within 90 days.

In case the Withholding Certificate is not received before purchasing the Replacement Property, the exchanger will not have access to the withheld funds. To avoid unintentional boot, additional cash can be contributed into the escrow or exchange account to cover the withholding amount. This ensures that 100% of the sale proceeds are available to buy the Replacement Property. Careful planning is necessary to allow sufficient time for the Withholding Certificate to be processed.

(3) Simultaneous Exchange with NO Boot: If the foreign exchanger engages in a simultaneous exchange, where there is no boot involved (including no debt relief), withholding is not required. However, the exchanger must provide the buyer (the other party involved in the exchange) with a signed “FIRPTA Notice of Non-Recognition Transfer” before the closing. This notice should include specific information and must be sent to the IRS within 20 days after the transfer date. This exception applies only to exchanges that do not involve any additional consideration (boot) other than the properties being swapped.

Other Required Documents

Foreign exchangers must provide the Qualified Intermediary (QI) with an IRS Form W8-BEN (instead of a Form W-9) disclosing the Exchanger’s Individual Tax Identification Number (ITIN). It’s crucial for foreign individuals or entities to obtain an ITIN using IRS Form W-7 before proceeding with the exchange to ensure compliance with FIRPTA regulations.

In conclusion, FIRPTA is a significant federal law that regulates the sale of U.S. real estate by foreign persons. Understanding the withholding requirements and exemptions is essential for foreign investors aiming to navigate the complexities of FIRPTA and facilitate successful real estate transactions in the United States.

As always, Peak 1031 Exchange, Inc. cannot provide tax or legal advice and taxpayers are strongly encouraged to speak with their CPA or tax attorney regarding the impact of the FIRPTA requirements on their specific transactions.

Have questions?

If you or someone you know has questions about the 1031 exchange process, our team of experts at Peak 1031 Exchange are here to help. Contact us today at [email protected] or by calling us at 818-960-7019 to discuss the deferral of capital gains taxes with a 1031 exchange.

As each situation is unique, exchangers should always seek the guidance of an attorney or tax advisor.

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