Purchasing real estate in the US can be a relatively simple process for non-US residents and foreign investors. There is no citizenship requirement to buy a home in the US, and, despite the effects of the pandemic, the residential housing market has continued to grow exponentially. In 2021, foreign buyers purchased $54.4 billion in residential real estate and $34.3 billion in commercial real estate in the US.
While purchasing US real estate can be an attractive opportunity, foreign investors should consider the tax implications of selling US real estate. You may be subject to capital gains tax, and the IRS, powered by the legislation in the Foreign Investment Real Property Tax Act (FIRPTA), will ensure the collection of income tax when it comes time to dispose of your US property through withholding. And, because a disposition can be via sale or transfer, gifts and inheritances constitute taxable events as well, even though no money exchanges hands.
The Foreign Investment Real Property Tax Act (FIRPTA)
Under FIRPTA, foreign investors must pay US income tax on Effectively Connected Income (ECI). Gains attributable to the disposition of US real property interests (USRPIs) qualify as ECI. A USRPI can be a direct interest in real property located in the US, an interest in a US Real Property Holding Corporation (USRPHC), or an interest in a partnership to the extent the gain on its disposition would be attributable to USRPIs. Whether the USRPI is direct or indirect, the foreign investor must withhold a portion of the sales price to satisfy their tax obligations related to the gain. FIRPTA withholding tax rates vary based on the type of ownership.
|Type of Ownership||Action||Withholding||Notes|
|Foreign person, partnership, trust or estate||Disposes of US property||15% of the fair market value||15% should not exceed the actual tax liability, so the investor can apply for reduced withholding using form 8288-B|
|Foreign investor||Sells shares in a domestic corporation that holds real estate||15%|
|Foreign investor||Sells shares in a foreign corporation that holds US real estate||No withholding tax is required*||*Unless the foreign corporation made a Section 897(i) election to be treated as a US real property holding company|
|Foreign investor||Sells their interest in the partnership||10% or 15%||Withholding depends on the assets of the partnership|
|Foreign corporation||Disposes of US real estate||15%||Potential for a branch profits tax|
|Foreign corporation||Distributes a USRPI||21% of the gain it recognizes on the distribution to its shareholders||In this case, the foreign corporation is distributing real property, as opposed to selling it and distributing the cash|
|Domestic US. partnership with foreign partner(s)||Disposes of real property||No withholding tax is required||Partnership must pay 35% of the gain allocable to direct foreign partners|
|Domestic US. corporation with foreign shareholder(s)||Disposes of real property||No withholding tax is required||Corporation will pay the corporate tax rate of 21% on the gain.|
Structuring Domestic Real Estate Investments
If a foreign corporation makes a direct investment in US real estate, the US corporate tax applies, and a 30% branch profits tax may apply to an amount equivalent to the foreign corporation’s dividends. FIRPTA withholding will apply on taxable dispositions of USRPI. There will be no additional US withholding taxes at the shareholder level on dividend distributions from the foreign subsidiary to the foreign parent or from the foreign parent to the shareholders.
If a foreign investor acquires and owns US property through a U.S. C-corporation, it will pay the corporate tax rate of 21% upon selling the property. Under certain circumstances, branch profits tax and dividend tax can be avoided through liquidation of the corporation after the sale.
If a foreign corporation holding a USRPI wants to be treated as a domestic corporation for FIRPTA reporting purposes, the corporation may file an 897(i) Non-Discrimination Election. In this case, the corporation would have no withholding requirement for the disposition of the USRPI and would pay the US corporate tax rate of 21% on the gain.
Reporting and Paying FIRPTA Tax
Estates, trusts, corporations, and partnerships that must withhold tax on distributions and other transactions involving US real property interests will need to file Form 8288, US Withholding Tax Return for Dispositions by Foreign Persons of US Real Property Interests and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of US Real Property Interests. US buyers of real estate from foreign owners must withhold the FIRPTA withholding from the proceeds.
To do so, the seller must have an Employer Identification Number (EIN). An entity must submit Form SS-4 to request an EIN. If you mail the application to the IRS, generally, they say it can take up to 4 to 5 weeks to receive an EIN. However, taxpayers may want to consider allowing more time or applying online, via fax, or by phone, as the IRS is experiencing mail backlogs and delays due to COVID-19.
Exceptions from FIRPTA Withholding
There are always exceptions to the rule. Provided all applicable notification requirements are met, FIRPTA withholding is generally not required when:
- You acquire a residence in the US for a sales price of $300,000 or less and – during each of the first two 12-month periods following the date of transfer – plan to reside there (or have a family member reside there) for at least 50% of the total days the property is used by any person.
- You receive a certification from the transferor or a qualified substitute, such as an attorney or title company, stating, under penalties of perjury, that:
- under the IRS’s qualifying criteria, the interest is not a US real property interest; or
- the transferor is not a foreign person.
- You receive written notice from the transferor stating that no recognition of any gain or loss on the transfer is required (based on either a nonrecognition provision in the Internal Revenue Code or a provision in a US tax treaty).
- The property disposed of is an interest in:
- a domestic corporation, if any class of stock is regularly traded on an established securities market; or
- a publicly traded partnership or trust;
- however, this does not apply to certain dispositions of substantial amounts of non-publicly traded interests in these publicly traded entities.
- The amount you realize on the transfer of a US real property interest is zero.
- You receive a withholding certificate from the IRS.
Foreign investors may apply for a withholding certificate by filing Form 8288-B. The IRS may issue a withholding certificate for claims based on a calculation that shows withholding would exceed the actual tax liability, special installment sale rules, or nonrecognition treatment or tax exemption. An entity must have an Employer Identification Number (EIN) to apply for a withholding certificate.
Form 8288-B must be submitted before the date of the transaction. Generally, the IRS requires up to 90 days to process the application. However, taxpayers should consider allowing more time for the IRS to process their application, as they are experiencing delays due to COVID-19.
For foreign investors, the tax implications of selling US real estate are complex. As a member of Russell Bedford International, LGA has the network, knowledge, and resources needed to address a wide variety of international tax needs for businesses and individuals.
Ahead of their investments, I help clients understand how FIRPTA will affect the sale of their real estate or real property interests in the US. And when it is time for a sale or transfer, I help them ensure FIRPTA tax compliance. If you have questions or would like to discuss your international tax needs, contact me today.
Larry Andler is a partner at LGA and has over 25 years of experience helping clients of all sizes and industries with their accounting and tax challenges. He works with high-net-worth individuals with complex reporting issues and their related businesses and trusts. Larry’s focus is assisting individuals and entities as they navigate the maze of the US tax system’s inbound and outbound foreign reporting requirements. He holds a US International Tax Certificate issued by AICPA & CIMA.