The IRS Rule That May Cost You 15%

Did you know real estate buyers in the U.S. are required to ensure the seller is either a U.S. citizen or has a U.S. government-issued tax identification number? Otherwise, the buyer could be responsible for a 15% tax bill to the IRS, based on the Foreign Investment Real Property Tax Act (FIRPTA) established in 1980.

The purpose of the law is to ensure all foreign investors pay the IRS the taxes due based on gains from the sale of U.S. real property.

The Challenge

If the seller is not a U.S. citizen or does not otherwise have a tax ID number issued by the U.S. government, then the government holds the buyer responsible to have the necessary exemption documentation, or the buyer must withhold up to 15% of the gross proceeds and pay it directly to the IRS. If the money is not withheld according to this law, the buyer may also be required to pay penalties.

Normally a buyer satisfies this requirement by having the title company obtain an executed and completed Evidence of Non-Foreign Status form from the seller. This form must include the seller’s U.S. taxpayer ID. This typically settles the matter unless the seller is indeed not a U.S. citizen or does not have a tax identification number. If the seller does not have the required tax ID number, then unless the seller is willing to have the buyer withhold 15% of the gross proceeds from the sale, the seller must file certain documentation with the IRS, which can delay the sale of the property.

FIRPTA Exemptions

Many real estate investors and the professionals who advise them are aware of certain exemptions to the law, such as a personal residence exemption (depending on the price of the sale), a withholding certificate, and affidavit of non-foreign status.

An often-missed requirement, however, is related to a potential foreclosure. If a property owner transfers the property title to the lender as a deed in lieu of foreclosure instead of going through the foreclosure process, the transaction may also be required to comply with the withholding requirement. However, the transaction can still be considered exempt from FIRPTA provided certain conditions are met. These include:

• The recipient of the property must assume all debt (if any) secured by the real property.
• The transaction must not be structured for the specific purpose of avoiding any required FIRPTA withholding.
• The recipient must ensure no substantive withholding liability is involved in the transaction.

Consulting with a real estate attorney about all the documents necessary for a legal real estate transaction before the transfer can save the transferee, whether a buyer or a lender in a foreclosure situation, a lot of money, time, and aggravation.