If you are at all involved with real estate investing, you might hear industry professionals use the term FIRPTA. If you're wondering what the acronym stands for, you're not alone.
FIRPTA is a complicated tax structure that applies to foreign investment in real US property. Although understanding FIRPTA is an involved process, we're here to make it easy for you!
What does FIRPTA stand for?
FIRPTA stands for Foreign Investment in Real Property Tax Act. The United States Congress passed this law in 1980, so some people refer to it as the Tax Act of 1980.
Before this law, Congress noticed that many foreign nationals (people who are not US citizens) owned property in America. These people were earning a passive income from these properties as investors. They were also earning money from selling these properties. However, they were not paying any income tax on them—even though they were technically earning the money in America and being paid in US dollars.
So, Congress passed FIRPTA to impose an income tax on these foreign investors at regular tax rates. The foreign person or the foreign corporation only pays on the amount of gain considered recognized.
Essentially, the law makes sure that people earning money off of real estate transactions based in America pay their fair share of taxes for it.
The PATH Act: Big Changes to FIRPTA
In 2015, the Protecting Americans from Tax Hikes (PATH) Act altered some of FIRPTA’s rules.
The main changes are this:
The first is that if a foreign-owned pension fund uses real estate to generate income it can be exempt from the rules of FIRPTA. However, it can only be exempt if it meets a long list of qualifications. These are things like being highly regulated and having many members, some of whom must be US nationals.
The second is that the percentage of publicly traded stock that a non-US investor can own increased from 5% to 10%. This stock can only be from a public REIT (real estate investment trust). It cannot be from a RIC (regulated investment company). If it is from the latter, then it still will not qualify for the exemption from FIRPTA.
The third thing is that the tax withholding rate on the sale of various US real property interests by non-US persons increased from 10% to 15%.
Finally, the act introduced the idea of Domestic Control Determinations. This means that if a certain percentage of stockholders are American, then the fund can be treated as American.
How does FIRPTA work?
Real property is just another word for real estate. It means that you own immoveable land.
When investors speak of their real property interest, they simply mean how much of the property they actually own. This is because they usually share ownership with other investors and developers.
For FIRPTA, the taxpayer has a withholding rate of 15%. The withholding rate is only 10% on money made before February 17, 2016.
These withholdings are only applicable to the “amount realized.”
To find the amount realized, you'll need to add:
- The principal cash that was paid or will be paid, and
- The fair market value of other property transferred or to be transferred.
The IRS understands that there are many unique situations when it comes to investing. So, like with many rules, there are many exceptions.
What is a FIRPTA affidavit?
A FIRPTA affidavit is a form that the seller of the property fills out.
It declares, under penalty of perjury, that the seller is not a foreign person. The seller will need to provide his US taxpayer identification number, usually a social security number, as proof. They must send this form to the IRS.
What is tax form 8288?
There are two types of tax form 8288.
- The seller of a property files tax form 8288.
- The agent involved in the property transfer files tax form 8288-A.
The IRS uses these forms to understand and keep records of real estate sales that involve foreign investors or entities.
This way, the taxation agency can be sure that sellers are paying the correct amount of tax and also receive the right amount of credits.
How long do you have to wait for FIRPTA withholdings?
The 15% FIRPTA withholdings remain with the title company or closing agent for around 90 days. During this period, the IRS processes the application.
Once the IRS has processed the application, they can issue a withholding certificate. Once the title company receives that certificate, it can release the cleared funds back to the seller.
Who’s responsible for FIRPTA withholdings?
The buyer is responsible for FIRPTA withholdings. According to the IRS, the buyer must withhold the potential income tax when purchasing from a foreign entity. If the buyer does not make the payment, then they are liable to penalties from the IRS up to and including seizure of the property.
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