Foreign Investment in Real Property Tax Act “FIRPTA”
FOREIGN SELLERS – BUYERS OWE THE IRS TAX
Congress enacted the Foreign Investment in Real Property Tax Act (“FIRPTA”) in 1980.
It is a little known IRS rule that buyer’s owe the seller’s income and/or capital gain tax when purchasing California property from a “Non-Resident Alien.”
For example, assume that you are purchasing a single family residence for $1,000,000 for investment purposes from a Non-Resident Alien seller living in China. The IRS requires you, as buyer, to remit 15% of the gross sales price to IRS at close of escrow.
This means that you, as buyer, must instruct escrow to pay IRS $150,000 of seller’s proceeds (15% x $1,000,000) to the IRS. If you, as buyer, fail to instruct escrow to pay IRS $150,000 of seller’s proceeds at close, then IRS will look solely to you for payment if the seller fails to pay the tax.
Who is a “Non-Resident Alien?” A “Non-Resident Alien” is any non-citizen seller who does not pass the (1) green card test or (2) substantial presence test.
Green Card Test: If a non-citizen has a current green card, then he is not a
Substantial Presence Test: If the non-citizen has resided in the U.S. for 183 days during the last 3 years and resided in the U.S. for at least 31 days this year, then he is not a “Non-Resident Alien.”
All other sellers are subject to mandatory IRS withholding. Surprisingly, it is the buyer’s obligation to demand withholding of seller’s proceeds at close.
If buyer fails to withholding of seller’s proceeds at close, then the IRS will look to the buyer for payment. Incredible but true.
Exemptions for Withholding?
This IRS rule requiring buyers to withhold sellers’ tax is the general rule subject to only two exemptions.
Exception #1: The transaction is exempt from IRS withholding if buyer purchases the property as his/her primary residence. The primary residence exception only applies if buyer can prove that he/she occupied the residence 50% of the time during the 24 month period immediately after close of escrow.
Exception #2: The transaction is except from IRS withholding if seller completes a 1031 exchange when both of the following conditions are met:
1. The Non-Resident Alien completes a simultaneous exchange (i.e. closes the 1031 on the same day as buyer’s purchase); and
2. The Non-Resident Alien receives no cash at close.
In all other 1031 exchanges where seller does not close simultaneously, the buyer must withhold 15% of gross proceeds from seller’s proceeds.
If you represent a buyer, and the seller is a Non-Resident Alien (i.e. does not pass either the green card or substantial presence tests), then advise your buyer to consult CPA prior to close of escrow to determine the amount of tax to withhold from seller’s proceeds.
If you represent a Non-Resident Alien seller, then advise seller to consult with his CPA as he may qualify for a Withholding Certificate, which would allow him to avoid the mandatory withholding.
Sellers desiring to avoid the mandatory withholding must first complete the Application for Withholding Certificate which generally takes the IRS 90 days to either grant or deny. Your seller will certainly need a CPA for this process.
Although agents should never give legal or tax advice, it is important that agents are aware that buyers have this tax obligation.