Comply with FIRPTA or pay IRS 10% of the sale price!

What is FIRPTA?

Since 1985, when the U.S. enacted the Foreign Investment in Real Property Tax Act, or FIRPTA, a withholding tax was imposed on the sale of all U.S. real property interests (USRPI) including the sale of real property (i.e., homes, condos, multi-family residences, commercial property, etc) by a "foreign person." For individuals, this refers to any nonresident alien. The law also applies to foreign corporations, foreign partnerships, and domestic trusts and estates with foreign fiduciaries, all of which are generally considered "foreign persons" for federal tax purposes.

Under FIRPTA, the buyer (or transferee) is generally required to withhold 10 percent of the gross sales price if the seller is a foreign person. The amount withheld must then be sent to the Internal Revenue Service within 20 days after the sale closes.

In order to comply with FIRPTA, during the sales transaction, a Buyer must obtain a fully executed Seller's affidavit of non-foreign status as well as the Seller’s tax identification number, or they must withhold 10% of the sales price and submit to the IRS within the time specified by FIRPTA. Generally, the escrow company involved in the transaction will assume the responsibility of withholding the correct amount from the Seller, but it is important for the Buyer to understand that under the Federal Law, the Buyer is ultimately responsible.

How does a Buyer comply with FIRPTA??

There are many circumstances of a transaction that will exempt a Buyer from FIRPTA’s withholdings requirements.  The most common exemption that will protect a Buyer is to require the Seller to furnish a fully completed "non-foreign affidavit" stating under penalty of perjury that the seller is not a foreign person (Internal Revenue Code § 1445(b)(2)). Additionally, the affidavit must also contain the seller's taxpayer identification number.

But this exemption is not available if the Buyer has actual knowledge that the affidavit is false, or if an agent in the transaction informs the Buyer that it is false, or if the IRS requests the Buyer to furnish a copy of the affidavit and the Buyer fails to comply.

In order for the Seller to comply, the seller has the choice of giving the non-foreign affidavit to the Buyer or to a "qualified substitute."  The qualified substitute must furnish a statement to the Buyer stating, under penalty of perjury, that the qualified substitute has the affidavit in his or her possession.  A qualified substitute is the person responsible for closing the transaction, which may include an attorney, Title Company, Escrow Company, or Buyer's agent (but not the seller's agent).

Additional exemptions from FIRPTA apply when the Buyer receives a "withholding certificate" (also called a "qualifying statement") from the IRS, stating that no withholding is required or when the property is acquired for use by the Buyer as the Buyer's residence and sells for no more than $300,000.  Other exemptions may apply but are less common.

What if the Buyer does not comply with FIRPTA?

If the Buyer does not properly require any withholdings from the Seller, then IRS can potentially assess the full 10% of the sales price that should have been withheld, or the seller's actual tax liability in the sale, whichever is less, plus interest and penalties, against the buyer.

Such action by the IRS can result against the Buyer if the Buyer fails to obtain the Seller's affidavit of non-foreign status and the Seller fails to pay taxes due on the sale. Even if the Seller eventually pays taxes on the sale, the Buyer can be liable for interest and penalties if the Seller is a foreign person and non-foreign affidavit was not furnished to the Buyer.

Additionally, an agent of the Buyer or Seller can also be liable to the IRS for the same 10% of the sales price that should have been withheld, or for the seller's actual tax liability in the sale, or for the amount of commission or other compensation received by the agent, whichever is less, plus interest and penalties, but only if: certain conditions exist.

Common Practice

Since the Buyer generally has no independent way of knowing whether the Seller is a foreign person, it is suggested that the Seller's affidavit of non-foreign status, or Buyer's affidavit that the property will be used by the Buyer as the Buyer's residence for the required amount of time or other appropriate documentation that no withholding is required be obtained in every transaction.  The agent should also comply with the above for protection from potential personal liability.

But proper compliance with FIRPTA laws requires the Seller to provide their social security number or tax identification number to the Buyer in order for the form to be valid. But these days, some Sellers may not be willing to provide this personal information so freely to the Buyer even through closing.

So, it is now a fairly common practice for the Sellers to provide their FIRPTA affidavits directly to escrow as long as the Escrow Company is willing to act on behalf of the Buyer’s and Seller’s agent as a qualified substitute. In these instances, the Escrow Company assumes the responsibility to notify all parties (the Buyer’s & Seller’s agent, Buyers & Sellers) that they have received a fully completed Seller’s affidavit of non-foreign status and thus must issue a form QS (Qualified Substitute Declaration of Possession of the Affidavit of Seller’s FIRPTA) to all parties signifying receipt of the Seller’s FIRPTA requirements.

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