Foreign Considerations in Real Estate Dispositions

• September 19, 2023
• Carey M. Heyman, CPA

Foreign persons¹ are generally not subject to Federal income tax on gains from the sale of a capital asset located in the United States, unless the capital gains are effectively connected with the conduct of a United States trade or business.  Internal Revenue Code (IRC) Section 897, which came online with the passing of the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), created a special rule for a gain derived by a foreign person from the disposition of a United States Real Property Interest (USRPI).  To qualify for nonrecognition of gain upon an exchange of an USRPI, a foreign person must acquire another USRPI that, immediately after the exchange, would be subject to United States taxation on its subsequent disposition.  To say it differently, foreign persons that invest in real property in the United States are eligible to defer a gain on exchanges of their property interests under IRC Section 1031.  If the foreign person’s relinquished property is a USRPI, then the FIRPTA reporting and withholding requirements will apply upon disposition.  

Any person who acquires a relinquished USRPI from a foreign person (a “transferee”) must deduct and withhold a tax in an amount equal to 15% of the amount realized (usually, the sales price) on the disposition by the foreign person, regardless of the amount of cash actually paid by the transferee.  This rate can be reduced to 10% if the transferee signs a personal use affidavit.  A “transferee” is defined as “any person, foreign or domestic that acquires USRPI by purchase, exchange, gift or any other transfer.”  If a transferee fails to deduct and withhold tax, which is required under IRC Section 1445, the transferee may be held liable for the payment of the tax, plus applicable penalties and interest. 

Withholding is not required if:

• The transferor is not a foreign person and provides the transferee with a certification of non-foreign status signed under penalty of perjury. 
• If an individual transferee acquires the USRPI for use as the transferee’s residence and the amount realized on the transaction is $300,000 or less.  This exception may apply to an exchange of a rental house that is sold to an individual who will use the house as a residence.²  

Withholding may be reduced or eliminated if a withholding certificate is obtained by either the transferor or transferee.  Careful planning is encouraged in order to allow for sufficient processing time by the IRS.  To avoid unintentional boot in an exchange, additional cash may be contributed to the qualified intermediary to avoid a potential shortfall.

Thanks to Kate Rypina for her help with this blog post! 

¹ A foreign person for the purposes of FIRPTA is a nonresident alien individual, foreign corporation [unless it has made a valid election under IRC Section 897(i)], foreign partnership, foreign trust, or foreign estate, but not a resident alien individual.  

2 Definitive plans need to be in place for the transferee to reside at the USRPI for at least 50% of the number of days that the property is used during each of the first two 12-month periods following the transfer date.  The number of days that the property will be vacant will not be taken into account in determining the number of days such a property is used.  A transferee shall be considered to reside at a property on any day on which a member of the transferee/buyer’s family, including brothers and sisters (whether whole or half-blood), spouse, ancestors and lineal descendants, resides at the property.

Sources: Thomson Reuters, Bloomberg Tax

Tags: 1031 Exchanges, FIRPTA, Foreign Investment in Real Property Tax Act, Foreign Investment in Real Property Tax Act of 1980, Section 1031 exchange, Withholding, Federal and state taxation, including proposed regulations, Year-end tax planning | Comments Off on Foreign Considerations in Real Estate Dispositions