Can Foreign Investors Avoid FIRPTA When They Sell?

The Florida real estate market has exploded over the past few years (and the past few decades, for that matter). Not surprisingly, foreign investors have overwhelmingly made Florida their favorite place to own U.S. real estate. The National Association of Realtors® reports that approximately 25% (i.e., $15 billion out of $60 billion) of international investments in U.S. residential real estate between April 2021 and March 2022 were in Florida. This was by far the highest amount among all U.S. states, and it was more than the combined percentages of California and Texas (the next two most popular states).

Investments in Florida real estate have prompted many foreign investors to ask questions about how to minimize their U.S. tax exposure. The two most common questions are:

• How do I avoid FIRPTA on the disposition of U.S. real estate?
• How do I avoid the U.S. estate tax if I die owning U.S. real estate?

This article will discuss the first question.

FIRPTA overview

The Foreign Investment in Real Property Tax Act (FIRPTA) imposes a tax on gains derived by foreign persons from the disposition of U.S. real property interests. Withholding of the funds by the buyer is required at the time of the disposition, and the payment must be remitted to the IRS within 20 days following closing. A sale is considered a disposition for this purpose regardless of whether the buyer is from the U.S. or foreign.

In addition, foreign investors are often surprised to learn that a FIRPTA disposition may also occur when the foreign investor reorganizes his or her ownership structure (e.g., by adding/changing companies or trusts, or adding family members onto the property deed).

Foreign investors should be aware of certain FIRPTA misconceptions as well as strategies to minimize/eliminate FIRPTA altogether.

Common FIRPTA misconceptions

The most common FIRPTA misconception is foreign investors believing that the FIRPTA tax can be avoided (when they ultimately sell the property) if the property is owned through a single-member limited liability corporation. Unless the LLC makes an election on IRS Form 8832 to be treated as a C Corporation for U.S. tax purposes, FIRPTA will still apply as the IRS will look through the LLC and treat the LLC’s owner as the owner of the real estate. LLCs can be great planning tools; however, they may not help a foreign investor avoid FIRPTA.

In addition, foreign investors should also be aware of the following FIRPTA issues and misunderstandings:

• Determination of whether FIRPTA applies solely relates to the U.S. income tax residency status of the seller. FIRPTA applies regardless of whether the property is sold to a U.S. individual or entity, foreign individual, foreign entity or otherwise. Thus, FIRPTA cannot be bypassed because the foreign investor sells to a foreign buyer.
• Failure to provide the buyer with confirmation of the seller’s foreign status does not eliminate FIRPTA. We have worked with many foreign investors who mistakenly thought that simply telling the buyer they were U.S. tax residents or refusing to answer the residency question altogether would be sufficient to avoid FIRPTA. This strategy only leads to bigger problems and does not avoid FIRPTA.
• Property sold at a loss (or no gain) is subject to FIRPTA. Many foreign investors believe that FIRPTA does not apply (and thus the buyer is not required to withhold the FIRPTA tax amount) if the seller is not making a profit on the transaction. Unfortunately, this may not be correct. Instead, the avoidance of FIRPTA withholding in such cases may require certain tax planning and compliance strategies (some of which are discussed below).

Links to /news-media/infographics/tips-buying-real-estate-us-transactions

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How to avoid (or minimize) FIRPTA

The good news is that there may be many strategies to eliminate (or at least, minimize) FIRPTA, depending on the facts. For example, many people may completely avoid FIRPTA by obtaining an IRS Withholding Certificate prior to the transaction. In particular, the seller should file a tax form to explain to the IRS that the sale will result in zero gain, or a gain that is small enough so that the related gains tax will be less than the FIRPTA withholding tax amount.

Remember, the FIRPTA tax is calculated based on the sale price (i.e., it is a gross tax), thus, FIRPTA does not consider what the seller’s tax basis may be. In contrast, the U.S. income tax system is generally based on “gain” (i.e., sale price minus tax basis). Thus, in many situations, the tax (generally 20%) imposed on the “gain” earned from the sale of the property may be zero or at least much lower than the FIRPTA withholding amount (which is based on a flat percentage, generally 10% or 15% of the sale price). If so, withholding certificates will relieve the seller from significant “over-withholding” and the need to wait months to seek a refund from the IRS of these “over-withheld” amounts.

The IRS form used to achieve this ideal withholding reduction is called Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests.  Make sure to prepare it timely and accurately and provide it to the buyer before the closing date. Otherwise, the buyer will need to perform the withholding (absent an additional exception applying, e.g., the de minimis sale exception), and the seller may be required to seek a refund, which can take many months (unless you are able to expedite the process, which oftentimes a FIRPTA tax expert may be able to help you achieve).

Based on the above traps for the unwary and FIRPTA avoidance strategies, it is best to check with a FIRPTA tax advisor to make sure that FIRPTA tax is not “over-withheld” as part of any sale transactions by foreign sellers. #

Christopher R. Callahan, Esq. is the co-chair of the International Taxation and Wealth Planning Practice CQ and a partner with Fox Rothchild LLP in Miami. This article should not be deemed legal advice. Please seek the advice of an attorney or tax advisor for specific questions.