Most REALTORS® in the United States who work in cities with a high volume of international business and investment, such as Houston, are aware that a special set of U.S. federal income tax rules exists with respect to sales of U.S. real property by foreign persons, generally called FIRPTA Rules FIRPTA stands for Foreign Investment in [U.S.] Real Property Act of 1980, which was enacted when Congress was concerned that foreigners, especially the Japanese, were buying up too much U.S. real property, including iconic properties such as Pebble Beach and the Rockefeller Center, but also farmland.
FIRPTA did, and does, essentially two things: First, it makes foreigners (both individual and corporate and any other type of entity) taxable on their gains from dealing in U.S. real property, even though foreigners are generally not taxable on gains from U.S. investment properties. Second, it imposes on the buyer of U.S. real property from a foreign seller the obligation to withhold a certain percentage of the gross sales price and remit that withholding to the U.S. Treasury as an advance payment of the foreign seller’s U.S. tax on the gain from the sale. The rules cover a broad range of transactions, but in its simplest expression, on a straightforward sale of a U.S. residence by a foreign seller, this means that the purchaser, whether U.S. or foreign, usually acting through the title company or other closing agent, must withhold and remit to the Treasury what used to be 10% of the gross sales price, unless the foreign seller is able to present a “withholding certificate” from the IRS reducing or eliminating the withholding because the actual tax owed is less than 10% of the gross sales price.
FIRPTA rules are still very much with us in 2016, but a new tax law passed in December of 2015, called “the PATH Act” – The “Protecting Americans from Tax Hikes Act” – made some important changes to the rules, especially these:
- Increase in the general rate of withholding from 10% to 15%: As noted above, the general withholding rate has long been 10%, but as of February 17, 2016, the general withholding rate has been increased to 15%. However, the rate remains at 10% if the property is to be used by the buyer as a personal residence and the gross purchase price (the “amount realized”) does not exceed $1 million. Essentially, these are the same requirements, except for the amount, as for the exemption from FIRPTA withholding (but not the basic taxation of the gain) for a personal residence for which the purchase price does not exceed $300,000. Thus, if the buyer will be using the property as a personal residence and the price does not exceed $300,000, there is no withholding, but if the price is greater than $300,000 but no greater than $1 million, withholding is at 10%. If the price is greater than $1 million, withholding is at 15%, always subject, of course, to the possibility that the foreign seller has obtained a “withholding certificate” from the IRS. These are broad stroke statements; there are a lot of details not addressed here.
- Expansion of the exemption for investments in publicly-traded REITs: Interests in a publicly-traded “REIT” – which means “real estate investment trust,” which is not itself taxable but attributes its income to its owners to be taxed – are not subject to FIRPTA taxation or withholding (on a sale of the interest or the receipt of a distribution attributable to the sale of U.S. real property) if the interest is no greater than a certain threshold. Before the PATH Act, this threshold was 5%, but as of December 18, 2015, the threshold is increased to 10%, encouraging additional foreign investment through REITs.
- New exemption for foreign pension funds: A new exemption is created for “qualified foreign pension funds,” whether government or private, that invest in U.S. real estate either directly or through partnerships or REITs. Again, this is an incentive to increase foreign investment in the U.S. real estate market. There are other FIRPTA provisions in the PATH Act not covered here, but the above are among the most significant. Overall, the changes are intended to encourage investment in U.S. real estate by “the big guys,” who can make the most impact, while tightening compliance by “the little guy” with an increase in the withholding rate.
Source: Allan Tiller is an attorney in Houston, specializing in international tax matters. He serves as an advisor to the HAR International Advisory Group. This article is for general informational purposes only and is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this article.