Withholding of Tax on Dispositions of U.S. Real Property Interests
International Tax Gap Series
It’s no secret that foreign investors are being courted by U.S. real estate agents and other investment conduits with eye-popping deals to buy real property in the U.S. The combination of a weak U.S. dollar and low interest rates has led to a phenomenal rise in the purchase of a U.S. real property interest by foreign investors. Eventually, these real property interests will be sold; therefore, foreign investors (transferors) and buyers (transferees) need to know their U.S. tax obligations when a disposition occurs.
This article, the sixth in a series relating to the international tax gap, explains the rules for proper withholding of tax on the dispositions of U.S. Real Property interest. It also clarifies who is obligated to conduct the required withholding of tax upon the foreign investor’s disposition of real property interests.
The Foreign Investment in Real Property Tax Act (FIRPTA) requires a FIRPTA withholding tax of 10% of the amount realized on the disposition of all U.S. real property interests by a foreign person. A buyer 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 person and the transferee fails to withhold, the buyer may be held liable for the tax. The seller must report that sale of the real property interests by filing a U.S. Federal Tax Form 1040-NR or Form 1120-F.
Obligation of the Buyer/Withholding Agent
If you are a foreign person or firm and you sell or otherwise dispose of a U.S. real property interest, the buyer (or other transferee) becomes the withholding agent and may have to withhold income tax on the amount you receive for the property (including cash, the fair market value of other property, and any assumed liability). Corporations, partnerships, trusts, and estates also may have to withhold on certain U.S. real property interests they distribute to you. See Reporting and Paying Tax on U.S. Real Property Interests.
Remittance of Withholding Tax
The withholding agent must remit the withholding of tax to the IRS by the 20th day of the date of the transfer on Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests. The withholding agent must also attached to Form 8288 a Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests, for each person for whom tax has been withheld.
U.S. Real Property Interest is any interest (other than solely as a creditor) in real property located in the United States or the Virgin Islands or certain domestic corporations.
Disposition means transfer of U.S. real property interest for any purpose of the Internal Revenue Code. This includes but is not limited to, a sale, exchange, capital contribution, redemption, distribution or gift.
Amount Realized includes cash paid, fair market value of other property transferred, and the outstanding amount of any liability assumed by the transferee.
Withholding Agent is the buyer (transferee) and is responsible for withholding and remitting the withheld amount on Form 8288/8288-A. The withholding agent is subject to penalties, interest, and the amount of tax required to be withheld.
Reduced Withholding of Tax
The foreign person disposing of a U.S. real property interest may have the 10% withholding reduced if certain conditions are met and Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests, is timely filed and accepted by the IRS. See exceptions from FIRPTA withholding and Withholding Certificates (reductions in 10% withholding).
Reduced withholding certificates may be submitted under the following situations:
The disposition of the U.S real property interest takes place under one of the non-recognition provisions of the Internal Revenue Code.
When the transferor’s maximum tax liability on the disposition is less than the amount otherwise required to be withheld.
The transferor or transferee wants to come under certain installment sale rules.
The transferor or transferee enters into an agreement with the IRS by posting a type of security (letter of credit, bond, etc.).
The transferor or transferee may enter into a 12 month agreement with the service to obtain a “blanket withholding certificate” for multiple properties.
A nonstandard application may be submitted for unique situations that do not fit into the above categories.
References and Links
For more information on dispositions of U.S. real property interests, see Publication 519, U.S. Tax Guide for Aliens.
Also refer to Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, for detailed instructions on how to apply for a withholding certificate under each of the 6 situations above.
The International Tax Gap Series