What is a FIRPTA Certificate?
FIRPTA is the short for the Foreign Investment in Real Property Act and is used to let the IRS know whether the person selling real estate is a foreign person or not.
The primary purpose of the FIRPTA certificate is taxation, foreign residents are generally exempt from most capital gains taxes, however, the real estate income is taxed. The FIRPTA certificate was launched to make sure that foreign sellers pay their dues to the IRS.
The FIRPTA Certificate
Under the FIRPTA rulings, any sale of a US real estate interest by a foreign seller is taxed under the 1980 Foreign Investment in Real Property Tax Act (FIRPTA) which you can read about o the IRS website here. In short, FIRPTA allows the U.S. to apply a withholding income tax on foreigners on sale proceeds of US based real estate.
The IRS defines the legal term used for the sale as a "disposition" which means a sale, trade, liquidation, gift, transfer, and redemption under the IRS's Internal Revenue Code. In IRS terms, people conducting any of the above activities with a foreign person are known as the transferee and are expected to hold onto 15% of the amount set for the transaction.
As an individual, if you want to buy a property, you need to report if the seller is a foreign person or not. If you do not do this, the tax liability can end up on you. Similarly, companies involved in real estate business with non-US entities can be under scrutiny from the FIRPTA authorities.
The Foreign Investment in Real Property Act (FIRPTA)
Since the IRS does not require foreign persons to file taxes, the FIRPTA certificate was launched to ensure that foreign people did not bypass their obligation and filed the income returns to report their sale proceeds after disposing of their U.S. Real Property Interests (USRPI). USRPI includes the following assets:
Holdings in property, like land, buildings, improvements, leaseholds, and natural deposits.
Holdings in any business partnerships that own USRPIs;
Any intangibles like goodwill that are directly tied to USRPIs.
Knowing how to apply the FIRPTA is essential while assessing the taxation due diligence of companies which can significantly impact the post-FIRPTA internal rate of return of a buyer's profit model. FIRPTA can also lead to added procedural requirements when building up a transaction.
For real estate based industries, listing what falls under the USRPI and how the FIRPTA is applicable can be challenging as the USRPI definitions are very broad.
The FIRPTA can also cover all mergers and acquisitions, including USRPHCs which stands for US Real Property Holding Corporations. These businesses hold some portion of USRPI assets and are therefore considered USRPHC. The IRS defines an organization to be a USRPHC if the market values of its USRPI properties are equal or more than 50% of its:
Holdings in property out of the US
Business assets (excluding #1 & 2 above)
Once a business is classed as USRPHC, it is treated as one for the next five years which can create severe tax and other complications for businesses looking to merge with others or acquire another business.
Knowing the status of a business's assets is essential when doing a taxable assets assessment. Many new (greenfield) projects are treated as USRPHCs as they usually have some USRPI holdings.
Since there are no other business assets, because the project is new, the USRPI is greater than 50% of their overall assets for the time being. The five-year USRPHC treatment means that these businesses are treated as USRPHCs for the first five years and are taxed differently than a non-USRPHC businesses.
Non-US citizens can usually sell off their stockholdings in a business without paying tax in the US, unless they hold shares of a corporation classed as a USRPHC. In this situation, a non-US personswill have to pay tax if or when they sell their shares in the USRPHC.
They will also pay tax if they get out dividends above their shareholding proportion in the USRPHC.
Buying under the FIRPTA
Buyers in an asset or stock transaction with businesses or people with real property interests should always determine if the FIRPTA is applicable.
If the buyer gets a USRPI from a foreign person, they must withhold 15% of the total sale amount and transfer it directly to the IRS within 20 days of the transaction being finalized. Withholding tax can be reduced and even eliminated if a request for withholding certificate Form 8288-B is already on record with the IRS.
Buyers must ensure that they withhold the correct amount of the withholding tax. If they fail, the buyer becomes liable to pay that amount of the seller's taxes and the onus of proving that the FIRPTA is not applicable lies with the seller.
The seller can share or show the forms or affidavits with the buyer which helps to prove that they are not categorized under FIRPTA. At times, however, sellers cannot do this, and the buyer ends up liable for the tax they inadvertently didn't collect.
Reasons to be Knowledgeable about FIRPTA
Both buyers and sellers must know about the scope and the applications of the FIRPTA, and this law and its associated rules are complicated to assess. The criteria of the USRPI are also challenging to apply, and some exemptions are made, which makes it even more complex to administer.
Sellers can apply some of these exemptions and bypass the FIRPTA based on some criteria. For example, if the investors are foreign pension funds or foreign government bodies, they may be exempt under specific sections of the FIRPTA. Sellers should be aware of the exemptions that they may be eligible for
Buyers should know about the rules that allow for the FIRPTA to be avoided to avoid unnecessary paperwork and penalties. Knowing if they are exempted or not can make the difference between a profitable and a loss-making deal at times.
The tax implications of the FIRPTA affect the bottom line for both buyer and seller, and knowing all the rules can help make the transaction smoother.
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