Best Practices for a Successful FIRPTA Withholding Application by Lewis Kevelson, CPA
Posted on February 15, 2021
Under U.S. tax law, foreign corporations and foreign persons deemed nonresident aliens (NRA) for tax purposes must pay U.S. taxes only on income they earn from U.S. sources. Therefore, an NRA that owns an interest in U.S. real estate will have a U.S. income tax liability only when he or she “disposes” of the property via an asset sale, exchange, liquidation, gift or transfer. The actual amount of the capital gain tax can be 20 percent for property held for more than one year or as much as 37 percent for property sold within one year of acquisition.
To ensure NRAs do not sidestep their U.S. tax obligations resulting from the sale of U.S. real property interest (USRPI), the Foreign Investment in Real Property Tax Act (FIRPTA) requires the property purchaser or transferee to withhold at closing and remit to the IRS a 15 percent tax on the gross sales price. The withholding can be considered a deposit applied against the NRA seller’s ultimate U.S. tax liability.
Along with withholding, the purchaser or transferee also has an obligation to file with the IRS Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests for each NRA disposing of real property located in the U.S. Both Forms 8288 and 8288-A must be filed by the 20th day after the date of the transfer.
If a transferee/buyer fails to deduct and withhold FIRPTA tax, he or she will be subject to IRS assessment and collection of the tax, plus accrued interest, as well as any applicable civil and criminal penalties. Should the seller of the U.S. real property interest (USRPI) file a tax return and pay the related tax liability, the buyer will no longer be liable for the withholding tax, but he or she will be required to pay all amounts of interest that may have accrued.
From the seller’s perspective, the amount of tax withheld by the buyer is typically greater than the seller’s actual U.S. federal income tax liability on the sale. Rather than having the seller wait more than one year to file a U.S. tax return and receive an overpayment refund, he or she may instead file with the IRS Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests, to request the required amount of FIRPTA withholding to be reduced or eliminated. At the same time, the seller must notify the buyer of its application for a withholding certificate for which the IRS generally takes 90 days to make its final determination on these matters. If the foreign seller files Form 8288-B, on or before the date of transfer, the buyer must withhold 15 percent of the amount realized in escrow but need not report or pay over to the IRS such amount (or a lesser amount as determined by the IRS) until the 20th day following the IRS’s final determination with respect to the application.
The timing of the filing requirements associated with a foreign NRA selling U.S. real property is a critical element both buyers and sellers must be careful to address. For example, the IRS considers the date of transfer of a USRPI to be the date on which “consideration is paid (or a liability assumed) by the transferee” and not the contract date. In other words, the transfer occurs at closing, when title is transferred to the buyer in return for payment. This payment commonly occurs after the passage of legal or equitable title, of earnest money, a good-faith deposit, or any similar sum that is primarily intended to bind the transferee or transferor to the entering or performance of a contract. Such a payment is presumed to be earnest money, a good faith deposit, or a similar sum if it is subject to forfeiture in the event of a failure to enter into a contract or a breach of contract. However, a payment that is not forfeitable may nevertheless be found to constitute earnest money, a good faith deposit, or a similar sum.
Failure to address these timing issues can result in a series of challenges for both buyer and seller, including likely IRS rejections of the seller’s Form 8288-B filing. For buyers, untimely filed Form 8288 and Form 8288-A and a failure to remit required withholding tax within the 20-day post-date of transfer timeframe can result in significant penalties and interest as well as personal liability for the outstanding tax.
Other Due Diligence Matters
All Form 8288-B filings related to sales of USRPI held by an NRA require careful and exacting attention to details to avoid rejection or processing delays from the IRS. For example, each of the following actions can put your withholding application in jeopardy:
- Failure to provide a reason for requesting a reduced withholding
- Failure to sign and date a withholding application
- Failure to properly and separately identify the address and use (personal or business) of the property/properties involved in the transaction(s)
- Failure to properly identify and separately name each seller, buyer, and the withholding agent involved in the transaction(s), including the contact information and taxpayer identification numbers for each party
- Failure to properly calculate the gain subject to withholding or provide adequate documentation of the seller’s basis in the property, including the purchase price, improvements, and depreciation schedules
- Failure to properly calculate the early refund available to the seller
Should the IRS request you provide additional information after you submit your withholding application, it is important that you respond by the required due date or risk rejection of your application. Such requests often occur when applications include claims for reduced withholding tax but lack relevant supporting documentation. Generally, the IRS will pause the processing of your original application until it receives the additional information requested from you, which may further delay the issuance of a withholding certificate.
To avoid an outright rejection of your application, confirm that the information you provide is accurate and does not contradict your claim for reduced withholding. If you discover a mistake, or if new and relevant information becomes available to you after you submit an applicant, you may file an amending statement as soon as possible to avoid rejection. Submission of amending statements generally extend the IRS’s time to act upon the withholding application by 30 days (or 60 days in the case of a substantial amendment and 90 days if the IRS already signed a withholding certificate.)
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he helps high-net-worth families, entrepreneurs and business owners structure transactions to comply with domestic and international tax matters while building and preserving wealth. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2050 or email@example.com.