FIRPTA, which stands for the Foreign Invest Real Property Tax Act, authorizes the United States government to tax foreign persons on the disposition of real property. The article below has been prepared by a Denver tax attorney to provide information related to FIRPTA.
What is FIRPTA?
If you are considered a foreign person for tax purposes, you may have special tax withholding requirements when it comes to disposing of an interest in real estate. Generally, the most common disposal of a real estate interest is through a normal sale. However, for purposes of determining FIRPTA requirements, a disposition can include a variety of transfers. FIRPTA stands for Foreign Investment in Real Property Tax Act of 1980. Note, for FIRPTA withholding requirements to apply, the property must be considered U.S. property (§1445(a)).
What is the rate of withholding?
Under Section 1445 of the U.S. Tax code, the current rate of withholding is 15% of the amount realized. For example, if the seller purchased the home 5 years ago for $300,000 and sold the house on June 1st, 2021 for $600,000, the amount realized is $600,000. Therefore, the required amount of withholding is $90,000. The gain on the property is $300,000, which may be subject to certain exclusions to income under §121.
Alternatively, if the seller sells the home and the purchaser conveys $500,000 cash and a $50,000 art collection, then the total amount realized to the seller would be $550,000. The total withholding requirement would be $82,500 in this scenario.
Are there exceptions to FIRPTA Withholding requirements?
According to Treasury Regulation 1.1445-2(a), the withholding requirements only apply to foreign persons, not those who are considered United States residents for tax purposes. In other words, if you satisfy the substantial presence test, you may be exempt from the withholding requirements under FIRPTA. There are various requirements for those who satisfy the substantial presence test, but may be lawfully in the United States under certain visas.
Section 1445(b)(5) also eliminates a withholding requirement where the amount realized on the disposition does not exceed $300,000 and is being acquired for use as a residence. Note, as described above, the amount realized is distinct from the gain realized.
What are the requirements for the Substantial Presence Test?
The Substantial Presence Test requires that taxpayers be physically present in the United States for a specific number of days to be considered a U.S. resident for tax purposes. First, the taxpayer must be present in the United States for a minimum of 31 days for the year in which the property is sold. Next, the taxpayer must be present in the United States for a minimum of 183 days over the past three years.
Note, there are special requirements for each year. A taxpayer may not simply remain in the U.S. for 183 days in year one and no other days for year two and three. Rather, the IRS will consider each of the days you were present in the current year (Year 3). Next, the IRS will consider 1/3 of the days you were present in the U.S. for the year prior (Year 2), and 1/6 of the days you were present in the U.S. for the year before Year 2 (Year 1).
For example, Taxpayer X was physically present in the U.S. for 240 days in Year 1. In year two, Taxpayer X was present in the U.S. for 180 days. In the current year, Taxpayer X has been present for 84 days. In total, the IRS will consider 40 days for Year 1, 60 days for Year 2, and all 84 days for Year 3, or the current year. This is a total of 184 days, and the taxpayer satisfies all the requirements for each year. In this situation, the taxpayer will be considered a U.S. resident for tax purposes and will not be subject to FIRPTA withholding requirements for the sale of the real estate.
Please contact The McGuire Law firm to speak with a Denver tax attorney to help determine if you are eligible to avoid FIRPTA withholding requirements and/or need assistance with tax issues dealing with the title company.