5 Key Provisions of the Real Property Tax Act You Should Know
FIRPTA is an acronym for Foreign Investment in Real Property Tax Act. It’s a United States’ federal tax law that imposes taxation on the proceeds realized from the disposition of real estate assets held by foreign persons.
FIRPTA was enacted in 1980 and is part of the Omnibus Reconciliation Act of 1980. The act mandates buyers of real estate properties held by foreigners to withhold a standard rate of 15% of the gross purchase price at the point of closing on the sale.
Below are the five most significant FIRPTA provisions every foreign real estate investor must know.
1. Provision on Taxable Assets
Most would-be foreign real estate investors associate FIRPTA with traditional real estate properties, such as residential and commercial buildings. But as you shall find, this federal tax law covers a host of other assets.
Ideally, the 15% FIRPTA withholding is levied on all United States Real Property Interest (USRPI).
Real Property Interest refers to interest realized from the disposition of all foreigner-held real estate properties in the United States and the U.S. Virgin Islands.
Those include gains related to residential and commercial buildings, farmlands, and minefields.
USRPIs also encompass the assets associated with the day-to-day administration of real estate properties. That means FIRPTA would apply to gains realized from selling home automation systems, business equipment, agricultural machinery, etc.
Shares related to real estate corporations are yet other assets taxed under FIRPTA’s frameworks. Therefore, it’s obligatory to pay FIRPTA withholding for selling, transferring, or liquidating your shares.
2. Provision on Parties
There are two primary parties in a FIRPTA arrangement. They include a transferor and a transferee.
A transferor refers to the foreign entity disposing of their U.S. Real Property Interest. The disposal may occur by means of a sale, exchange, or gift. It may also be through a transfer.
In FIRPTA arrangements, USRPI transfers entails distributing an investment to partners (in the case of a partnership), shareholders (for corporations), or beneficiaries (in the case of an estate or trust). The transfer can involve a portion of an investment or its entirety.
It’s also worth noting that a transferor in FIRPTA transactions may constitute an individual property owner or an agency acting on their behalf.
On the other hand, a transferee denotes the entity that acquires a U.S. Real Property Interest by means of purchase, gifting, exchange, or transfer. This could be an individual, company, or an agency working on their behalf.
However, unlike a transferor who must be a foreign national, transferees in a FIRPTA arrangement can be a domestic or foreign entity.
3. Provision on Taxable Gain
FIRPTA regulations mandate the transferee to withhold the statutory 15%. This reduces logistical challenges a transferor would face while making remittances to the internal revenue service (IRS), especially if they’re located far beyond the IRS’ functional jurisdiction.
It’s also important to note that all withholding is done at the time of closing on a real estate transaction. Besides, the amount is calculated from the gross purchase price.
For instance, assume that a transferor has agreed to dispose of a commercial apartment for $1,000,000. After extensive negotiations with an interested transferee, the seller waivers 5% of the initial listing price, bringing their new asking price to $950,000.
However, the buyer somehow determines that the property might require some renovation worth $5,000.
In that case, the transferee would renegotiate with the transferor for further discounts. If the seller refuses to concede, the buyer would levy 15% of $950,000, which is the substantial gross purchase price.
The transferee would then shoulder any additional costs associated with the transaction.
4. Provision on Timely Remittances
The IRS requires all FIRPTA withholding to be remitted within 20 days of making the deductions. So, a transferee has up to three weeks from the date of closing a real estate sale to submit the withheld amounts.
Late remittances may attract hefty penalties and interests. The penalties vary depending on the duration you took to submit FIRPTA withholding amounts to the IRS.
Moreover, there’s a $10,000 penalty for ignoring your FIRPTA withholding obligations.
You can submit FIRPTA withholding through Form 8288-A. Fill out the form, including your taxpayer identification number and that of the transferor.
There may be instances where a transferor is ineligible for a Social Security Number (SSN). In that case, they can apply to the IRS for an Individual Taxpayer Identification Number (ITIN).
As a transferee, it’s imperative to request all relevant details from the transferor and remit FIRPTA withholding to the IRS in time to avoid undue penalties.
5. Provision on Partnerships
There are instances where either the transferor or the transferee is a partnership rather than a single entity.
If a property is owned by more than one investor, all partners are entitled to a share of the amount realized from each transaction depending on their capital contribution. However, FIRPTA withholding would be levied on the total selling price rather than have each partner pay their individual taxes.
More importantly, the rate would now increase to 21%.
Note that it’s not the transferee’s prerogative to dictate how partners of a foreign-owned real estate property share the proceeds from the disposition of their assets.
The buyer’s role would be to deposit the selling price (less 15%) to the entity’s official bank accounts. It’s upon the partners to work out a profit-sharing formula based on their capital contributions and other applicable arrangements.
There are no major implications if a transferee in a FIRPTA arrangement constitutes a partnership.
Summary
Understanding the above FIRPTA provisions is critical for foreign real estate investors seeking to dispose of their assets. Staying up to date on FIRPTA regulations lets you tap into any tax advantages you could be eligible for, while avoiding the pitfalls commonly faced by foreign real estate investors.
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