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Prepping Foreign Sellers Early in the Process on FIRPTA Requirements Can Prevent Closing Table Issues

Prepping Foreign Sellers Early in the Process on FIRPTA Requirements Can Prevent Closing Table Issues

Recent changes to the Foreign Investment in Real Property Tax Act (FIRPTA) have shone a spotlight on the challenges facing real estate agents and settlement service providers when handling transactions for non-U.S. citizens selling their U.S. property. While there are indeed a few extra hoops to jump through when handling foreign-owned property, the requirements don’t have to be closing-table deal-killers, if all parties understand the rules and put procedures in place that will ensure a smooth closing.

Mark Loterstein, vice president and corporate counsel at North American Title, said the process must begin at the first listing appointment.

“The responsibility for educating the foreign seller really rests with the real estate agent,” Loterstein said. “We always instruct the agents we work with to educate the seller very, very early in the process, at the first listing appointment would be best. They can simply ask the client if they are a foreign seller, or ask if they have a Social Security number and if not, that would indicate they are a foreign seller.”

If a foreign seller’s FIRPTA obligations are not addressed prior to the closing table, the sudden realization that 10 to 15 percent of the sale proceeds must be withheld, could well kill the transaction on the spot, a situation no real estate agent wants to entertain. It is also very important to choose a closing or escrow agent, like North American Title, who is knowledgeable and skilled at handling the FIRPTA requirements at the closing table.

Why begin the process so early? To understand why encouraging your foreign seller to address the FIRPTA issue early in the process is so critical, here’s a brief background on FIRPTA and the recent changes.

FIRPTA Regulations

FIRPTA legislation was enacted in 1980 as a result of concern that foreign investors were purchasing U.S. real estate and then selling it at a profit without paying any tax to the United States. To solve the problem, FIRPTA established a general requirement on the buyer of U.S. real estate interests owned by a foreign seller to withhold 10 percent of the amount realized from the sale and remit it to the Internal Revenue Service at the time of closing unless certain exemptions are met. Those “exemptions” are the reason to start the process early, which will be detailed later in the article.

The withholding takes place at the closing, when the escrow officer or settlement agent withholds the required 10 percent of the sale proceeds and remits the funds to the IRS.

Recently enacted federal legislation, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), included amendments to FIRPTA, increasing the withholding rate from 10 percent of gross sales proceeds to 15 percent of gross sales proceeds for certain transactions. The following provisions now apply:

  • The current withholding rate of 10 percent will still apply in certain transactions (generally when the property will be used by the buyer as a residence), provided the amount realized from the sale does not exceed $1,000,000.
  • If the amount realized exceeds $1,000,000, then the withholding rate is 15 percent and may be calculated against the entire amount

Withholding vs. What Is Actually Owed

Although FIRPTA requires a certain amount be withheld on foreign-owned property transactions, that doesn’t mean the seller actually owes that amount, according to Loterstein.

“You have to remember that the withholding is a payment towards the tax the foreign person or entity may have,” Loterstein emphasized. “Through the FIRPTA process, the sellers can apply for a Withholding Certificate that could reduce the withholding – often reducing it to zero. Even if the sellers are going to owe some taxes, when they file the request for the Withholding Certificate with the IRS, they may be able to deduct closing costs, improvements they made to the property and other deductions, and they can get a net number, so the deduction will no longer be based on the gross sales proceeds. This allows foreign sellers to get a pre-determination either that they owe nothing, so no withholding will take place, or at least to get that amount reduced.”

This is where the real estate agent can be of great assistance to their sellers, Loterstein said.

“This process takes at least 90 days,” Loterstein said. “The important thing is to get it started on time. Either you owe the tax or not. If you do owe it, you can often get it reduced to a more manageable number. But this process can be very involved. The client may have to apply for a Taxpayer Identification Number (TIN) before even applying for the exemption and even that process is a little more burdensome than it once was.”

Although real estate agents and title and escrow agents cannot give legal or tax advice to home buyers and sellers, there is one piece of advice an agent can give to the client.

“The best advice you can give your foreign seller is ‘Speak to your attorney; go see your tax professional,’” Loterstein said. “As title and settlement agents, we can’t give them advice. Real estate agents should not give them advice. It is a very complicated process and they should get help from a professional, as there are both civil and criminal penalties for non-compliance.”

The liability can extend to the real estate agent as well, according to the National Association of Realtors (NAR), which released an Issue Brief on FIRPTA in January.

According to NAR, If the buyer of the real property receives a certificate from the seller that the seller is not a foreign person, and is therefore exempt from withholding, and the real estate agent for either the seller or the buyer has knowledge that the certificate is false, the agent must notify the buyer of this fact. Failure to do so could mean that the agent is liable for the tax that should have been withheld but was not.

Although the agent’s potential liability would be limited to the amount of commission he or she earns from the transaction, according to the NAR brief, this would not be the case for a withholding agent. If the agent serves as the withholding agent, that is he or she controls or has custody of income that is subject to the withholding, that agent may be held personally liable for the full amount of the FIRPTA withholding tax required to be withheld, plus interest and penalties.

The new FIRPTA amendments have not altered currently available exemptions, but real estate agents and attorneys are encouraged to direct their customers to engage their tax professionals early in the timeline of the transaction in order to achieve the most beneficial tax treatment. Some tax professionals may also recommend an early application for the refund of excess withholding. This is particularly important as the IRS has reported that refunds filed after withholding may take from six to 12 months to process.

Real estate agents and attorneys should also make sure the transaction is being handled by an agent, such as North American Title, that is knowledgeable about the FIRPTA requirements.

And finally, real estate agents and attorneys are urged especially to carefully review contracts for transactions scheduled to close after the effective date of the PATH Act – Feb. 17 – as many state contract forms have the 10 percent withholding amount pre-printed – a number that will need to be amended if the property falls in the higher tax bracket.

For more information about how North American Title can assist you with your FIRPTA transactions, please contact your local sales representative, or find an office near you