Achieving success in business doesn’t only require conducting extensive market research and making timely investment decisions. It also consists in keeping up to date with the corporate tax landscape, which is constantly evolving.
This article shall delve into one of the most misunderstood real estate taxes – FIRPTA. Read on as we uncover FIRPTA and how the Internal Revenue Service (IRS) levies this tax.
In the United States (as with most countries), real estate transactions constitute an official trade involving a buyer and seller. As such, the IRS subjects all property sales to taxation.
US citizens typically pay capital gains taxes on the profits accrued from the disposition of their real estate properties. However, foreign nationals with US-based real estate investments pay more in FIRPTA.
FIRPTA is an abbreviation for Foreign Investment in Real Property Tax Act (Withholding). The US Government enacted this withholding tax in 1980 to ensure foreign investors pay taxes on all real estate income generated on US soil.
The Foreign Investment in Real Property Tax Act Withholding is levied by the United States Federal Government on the profits realized from the sale of real estate assets by foreign investors. The seller could be an individual or corporate entity.
Various types of real estate investments are subject to FIRPTA tax. These include residential and rental properties, lodge facilities, and farmlands.
Profits generated by alien investors from disposing of their company shares are also subject to FIRPTA taxation.
As with any real estate transaction, the main parties in a FIRPTA arrangement are the property buyer and seller. The buyer is the transferee, whereas the seller is the transferor.
The transferor is typically an alien investor, and the transferee is a U.S. citizen.
FIRPTA aims to ensure that alien investors pay their fair share of taxes to the U.S. Federal Government. The withholding tax also helps to foster accountability by ensuring that foreigners with real estate properties in the United States do not engage in financial malpractices like tax evasion, especially while disposing of their assets.
By remitting taxes to the IRS, the tax body might conduct its research to establish if the transaction was above board. The goal is to ensure the seller isn’t trying to game the markets to the buyer’s detriment.
FIRPTA attracts taxation on the amount of profits considered recognized. The act requires alien investors who sell real estate property in the US to pay a 15% withholding tax on the property’s buying price.
The actual rates levied could be lower depending on the seller’s tax liability. In this case, the investor would need to notify the IRS before they intend to dispose of their property.
Besides paying the 15% tax, a property seller in a FIRPTA arrangement must submit the Foreign Investment Real Property Tax form (Form 8288) to the buyer and IRS.
It’s also worth noting that the actual property investor doesn’t have to pay FIRPTA withholding tax directly to the IRS. The tax agency allows the seller to be represented by a U.S.-based realtor for convenience. The realtor serves as the middleman between the investor and the IRS, processing and submitting the required tax documentation.
A foreign real estate investor ideally pays FIRPTA withholding tax, either directly or through an appointed US-based real estate agent.
However, the transferee deducts and withholds the tax on the amount the transferor realizes.
We’ve already hinted that the amount of FIRPTA you’ll pay depends on your tax liability.
For instance, FIRPTA withholding rates for foreign corporations amount to 21% of the gain. Limited Liability Company (LLC) property owners made up of a single member pay 15%. However, if the LLC operates as a partnership, the entity is exempt from FIRPTA tax rules.
In the case of joint property ownership, the amount withheld in FIRPTA is distributed across each transferor based on their capital contribution.
Also, FIRPTA only comes into effect for sales exceeding $300,000. That’s a welcome relief for small-time alien investors.
Lastly, foreign real estate investors from countries that maintain tax treaties with the United States are exempt from paying FIRPTA withholding tax. Examples of such nations include the United Kingdom and Canada. If you fall in this cohort of alien property investors, you must file form W8-BEN as proof that you’ve already been taxed locally.
The IRS maintains numerous tax forms that income earners must use for income reporting and tax filing.
The first form typically used for FIRPTA withholding tax is Form 8288, which reports any income generated from a US source and the applicable taxes.
Next is Form W8 BEN for nonresident aliens residing in countries with tax treaties with the U.S.
Lastly, there’s a W-9 that an entity must have before hiring a nonresident foreign individual to request a taxpayer identification number (TIN).
Understanding FIRPTA is essential for any foreign real estate investor intending to dispose of their property. We hope you’re now familiar with the concept of this withholding tax and will be able to navigate the relevant tax maze when it comes down to it.