Foreign Investment in Real Property Tax Act

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The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), enacted as Subtitle C of Title XI (the "Revenue Adjustments Act of 1980") of the Omnibus Reconciliation Act of 1980, Pub. L. No. 96-499, 94 Stat. 2599, 2682 (Dec. 5, 1980), is a United States tax law that imposes income tax on foreign persons disposing of United States real property interests. Tax is imposed at regular tax rates for the type of taxpayer on the amount of gain considered recognized. Purchasers of real property interests are required to withhold tax on payment for the property. Withholding may be reduced from the standard 10% to an amount that will cover the tax liability, upon application in advance of sale to the Internal Revenue Service. FIRPTA overrides most nonrecognition provisions as well as those remaining tax treaties that provide exemption from tax for such gains.

Overview[edit]

United States tax law requires that all persons, whether foreign or domestic, must pay income tax on dispositions of interests in U.S. real estate (U.S. real property interests). Domestic persons are subject to this tax as part of their regular income tax.[1] Internal Revenue Code sections 897 and 6039C were enacted in FIRPTA;[2] the Act also made conforming amendments to various other provisions of the Internal Revenue Code.

Foreign persons are taxed only on certain items of income, including effectively connected income and certain U.S. source income. Foreign persons, however, are not taxed on most capital gains. Internal Revenue Code section 897, as enacted by FIRPTA,[3] treats the gain on a disposition of an interest in United States real property as effectively connected income subject to regular federal income tax.

To ensure tax collection from foreign taxpayers, FIRPTA requires buyers of U.S. real property interests to withhold 10% of the sales price. The seller may apply to the Internal Revenue Service (IRS) to reduce this 10% to the amount of tax estimated to be due. The IRS routinely and quickly approves such seller applications.

FIRPTA applies in virtually all cases where a foreign owner of a U.S. real property interest disposes of that interest. Provisions of the law which would prevent recognition of gain generally do not apply unless the seller receives a U.S. real property interest in a qualifying nonrecognition exchange.

History[edit]

Prior to 1981, foreign persons (nonresident, non citizen individuals and non-U.S. corporations) often were exempt from U.S. tax on sale of real estate in the United States. Congress passed FIRPTA to require all foreign persons to pay tax on dispositions of any interests in U.S. real estate. The law specifically provided that its provisions took precedence over any existing tax treaties that provided otherwise.[4]

Persons and property subject to tax[edit]

Foreign persons are generally exempt from U.S. tax on capital gains.[5]

Under FIRPTA, however, foreign persons are subject to tax on gains from disposition of U.S. real property interests (USRPIs).

  • An interest in property is any direct equity interest in the property, such as a fee simple ownership, but does not include interests solely as a creditor. Thus, co-owners of property each hold an interest in the property, but a bank holding a mortgage does not.[6]
  • Real property is land, buildings, and land improvements.[7] Generally, whether property is or is not real property is determined under U.S. tax law concepts, not state law. Thus, gas pumps and awnings at gas stations are not real property under U.S. Federal tax law, even though they may be realty under state law. For FIRPTA purposes, real property also includes unsevered natural products of the land (e.g., oil and gas in place in the ground, uncut timber, unharvested crops) and personal property associated with the use of real property.[8]
  • A United States real property interest (USRPI) includes shares of a U.S. real property holding corporation (USRPHC). A USRPHC includes any U.S. corporation if more than 50% of such corporation's assets were USRPIs at any testing date.[9] Disposition of an interest in a USRPHC is subject to the FIRPTA tax and withholding but is not subject to state income tax. This may be compared with the disposition of a USRPI owned directly, which is subject to the lower federal capital gains rate but is also subject to the state income tax.[10]

Gain recognition[edit]

Taxpayers generally must recognize gain upon disposition of property. Where the proceeds are received in more than one year, the gain is recognized proportionately over the years received.[11]

Taxpayers exchanging property may not be required to recognize gain on certain transactions. Among these are like kind exchanges,[12] corporate formations,[13] contributions to or distributions from partnerships,[14] certain corporate reorganizations,[15] and certain other transactions. FIRPTA provides that such nonrecognition provisions generally do not apply, and gain must be recognized. Two exceptions do apply. First, gain is not recognized if the property received in the exchange is a USRPI which, if disposed of immediately after the exchange, would be subject to FIRPTA. Second, the IRS may provide other exceptions in regulations. Temporary regulations providing very limited exceptions have expired.[16] Regulations provide limited exceptions treating certain partnership interests as USRPIs, and thus nonrecognition.

Amount of gain[edit]

Under general U.S. tax principles applicable to FIRPTA, gain is equal to the excess of the amount of money or fair market value of property received over the amount of adjusted basis of the property exchanged.[17] Where the amount received is subject to a contingency, the amount is not recognized until the contingency is resolved.

Tax imposed[edit]

FIRPTA gain is subject to tax as effectively connected income.[18] Nonresident alien individuals are subject to tax on such income at regular graduated tax rates for U.S. individuals. The deduction for personal exemptions, certain adjustments to gross income, and most itemized deductions are not allowed. Foreign corporations are subject to tax on such income at regular corporate income tax rates. The branch profits tax under Internal Revenue Code section 884 may apply, subject to the branch termination exception. The Alternative Minimum Tax may also apply.

Withholding[edit]

Buyers of U.S. real property interests are required to withhold 10% of the full sales price on ANY purchase of a USRPI, subject to only four exceptions.[19] Withholding is not required:

  • By a purchaser for use as a residence for a price $300,000 or less, OR
  • Where the purchaser receives a statement from the seller that the seller is a not a foreign person.[20]
  • Upon acquisition of an interest in a nonpublicly traded domestic corporation where the corporation provides the required affidavit.
  • Upon acquisition of shares of a publicly traded corporation.

To the extent withholding is required, the amount of withholding may be reduced below 10% of the full price only upon certification by the IRS that a reduced amount applies. Such certification is permitted only if the seller applies to the IRS for reduced withholding by filing Form 8288-B no later than the closing date of the sale.[21] The certification will specify the proper amount of withholding, subject to the stated closing price.[22]

Penalties apply to a purchaser who fails to withhold, file Form 8288 with the IRS,[23] or pay the required withholding within 20 days of the sale.[24]

Treaties[edit]

Many U.S. tax treaties formerly provided exemption from tax for gains on dispositions of many sorts of U.S. real property. FIRPTA specifically provided that such treaty provisions would not apply after a particular date. Most U.S. tax treaties have subsequently been amended to conform with FIRPTA treatment.

Resources[edit]

IRS Publication 515

References[edit]

  1. ^ Domestic taxable persons (individuals, corporations, estates and trusts) are subject to income tax on taxable income. Taxable income is gross income, with adjustments, less allowable deductions. 26 USC 61 defines gross income as income from all sources, including specifically gains on dealings in property.
  2. ^ With respect to sections 897 and 6039C, see FIRPTA sections 1122 and 1123, respectively.
  3. ^ 26 USC 897, 26 CFR 1.897-1 through -9T.
  4. ^ Under the United States Constitution, laws and treaties have equal priority. All treaties that have been amended since FIRPTA was first considered have specifically permitted U.S. tax on dispositions of real property.
  5. ^ Foreign persons includes individuals who are not U.S. citizens or resident aliens, corporations organized outside the United States, and nonresident estates and trusts. See 26 USC 7701. Note that partners, not partnerships, are subject to tax, so foreign status is determined at the partner level. See, however, withholding tax for an overview of exceptions regarding foreign partnerships.
  6. ^ 26 USC 897(c), 26 CFR 1.897-1(c).
  7. ^ 26 CFR 1.897-1(b).
  8. ^ The regulations imply that for personal property to be associated with the use of real property the property must fall into one of four specific categories. The categories relate to natural resource extraction (wells, mines, etc.), construction, providing lodging, and providing office space. See 26 CFR 1.897-1(b)(4).
  9. ^ For a definition of USRPHC, see 26 USC 897(c)(2) and 26 CFR 1.897-2.
  10. ^ Stein, Jacob. "Tax Planning for Foreign Investment in California Real Estate". Los Angeles Lawyer. Retrieved March 15, 2013. 
  11. ^ Under 26 CFR 1.897-1(d)(2)(ii), an installment obligation on sale of a USRPI is treated as a USRPI if the seller does not elect out of the installment gain rules of 26 USC 453. Thus, installment sale treatment applies to foreign persons selling USRPIs.
  12. ^ 26 USC 1031.
  13. ^ 26 USC 351.
  14. ^ 26 USC 721 and 26 USC 731.
  15. ^ 26 USC 354 through 358
  16. ^ 26 CFR 1.897-6T.
  17. ^ 26 USC 1001.
  18. ^ See 26 USC 872 and, which excludes most income except effectively connected income from the gross income of nonresident, noncitizen individuals. The non-excluded amounts are subject to the same tax imposed on domestic persons. See note above. See 26 USC 882, which explicitly imposes tax on income of a foreign corporation connected with a U.S. trade or business.
  19. ^ 26 USC 1445.
  20. ^ The statement must be provided under penalties of perjury. For text of the statement, see 26 CFR 1.1445-2(b)(2)(i) .
  21. ^ The IRS generally provides such certification within 30 days when the application contains all required information.
  22. ^ Where the seller has applied for but not received such certification, prudent buyers will have the full 10% held in escrow at closing. Amounts so held in escrow are not subject to penalties if remitted to the government within 20 days of IRS notice of required withholding.
  23. ^ For filing requirement, see 26 USC 6039C.
  24. ^ For payment requirements, see 26 USC 1461 and 26 CFR 1.1461-1.