Foreign real property owners are subject to certain withholding requirements when selling their U.S. property. In a real estate transaction involving a foreign seller, the Foreign Investment in Real Property Tax Act (“FIRPTA”) requires ten percent of the gross sales price be withheld from the sales proceeds received at closing. This withholding is remitted to the Internal Revenue Service as a deposit on the income tax liability generated from the sale. When the actual Income tax resulting from the sale is reported on the seller’s tax return, the withholding will be applied and the seller will either remit a sum to satisfy the outstanding balance or will receive a refund of any excessive withholding.
The withholding requirement does not apply to sales of real property that do not exceed $300,000 if the purchaser intends to make personal use of the property as a residence for at least fifty percent of the time the property is in use, for at least two consecutive years following the date of purchase. This exception is not available to business entities, trusts, or the sale of unimproved property.
FIRPTA also applies to short sale transaction and may present hurdles in negotiations with the lender. If a short sale does not qualify for the above-referenced FIRPTA exception, the seller should take the necessary steps to apply to the IRS for a withholding certificate which grants a reduction or elimination of the ten percent withholding requirement. Application and processing of a withholding certificate requires additional time and should be considered when negotiating the terms of a short sale contract.
On the other side of the transaction, a foreign purchaser of real property should also consider the benefits of different forms of real estate holding. There are varying income and estate tax consequences for foreign individuals and foreign-owned business entities holding, renting, transferring and devising U.S. real estate. These consequences depend on a number of factors, including the domicile of the owner, value of the property, and the income produced from the property. Each owner’s circumstances and goals should be evaluated to determine the most beneficial way to take title to real property.