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FIRPTA - What are my options as a seller?

FIRPTA WITHHOLDING SELLER OPTIONS

FIRPTA – Foreign Investment in Real Property Tax Act

As a US non-resident when you come to sell your property you will be subject to FIRPTA unless an exception applies to your sale, for the sale of a rental investment property it is uncommon for one of the exceptions to apply unless your buyer is intending to use the property as their primary residence and is willing to sign an affidavit confirming this.

In our experience even if the buyer intends to use the property as their primary residence many are unwilling to sign the affidavit because even though they they may meet the withholding exemption they are still responsible for the seller’s tax liability, interest and penalties should the seller not file a US income tax return to report the sale and pay any relevant taxes.

Assuming that an exemption does not apply when you sell your property the IRS will require your Settlement Agent/Attorney to withhold 15% of the contract price. This is done to ensure that you fulfill all of your remaining US tax obligations before you repatriate your funds from the US.
The 15% is considered by the IRS an estimated tax payment to cover any outstanding Capital Gains or Income Tax liabilities you may have on disposal of the property. 

Any excess tax that is collected over and above your final tax liability will be refunded either 

1. As part of the settlement process if an 8288B is filed with the IRS prior to the sale.      
2. When you complete your annual tax return for the year in which the sale takes place. 

Although the withholding is collected from your sales proceeds it is the buyer’s obligation to ensure that any FIRPTA tax liability is withheld and paid over to the IRS. In our experience the seller will always be required to pay for the preparation and filing of the appropriate documents and it is to their advantage to ensure that the process is completed correctly. If the seller does not obtain the correct documents from the IRS they will not be able to claim a refund of any excess withholding greater than their tax liability.   

In some cases the Settlement Agent/Attorney will act as the withholding agent, sign the documents on behalf of the buyer and will send the withheld funds to the IRS. However in most case the Buyer acts as the withholding agent.

The Process

Once your sale is under contract you have two choices with regard to the FIRPTA withholding

1. File an 8288B and agree a reduced level of withholding with the IRS
2. File an 8288 & 8288A and allow 15% of the contract price to be withheld

Filing the 8288B - THIS HAS TO BE FILED PRIOR TO OR ON THE DAY OF THE SALE OR WILL BE REJECTED BY THE IRS.

In order to file an 8288B your tax affairs must be current.

When you file an 8288B with the IRS you are basically negotiating the actual Capital Gains tax liability on the sale. In most cases this will be significantly less than the 15% withholding tax.

The IRS apply a 20% Capital Gains withholding rate to the agreed Capital Gain.

Hence if an investor sells a property for $150,000 which includes a total capital gain of $20,000 by filing the 8288B the Withholding amount would be reduced from $22,500 (15% of the $150,000 Contract Price) to $4,000 (20% of the $20,000 gain).

Filing the 8288B will not delay your sale, in the example above the Settlement Agent/Attorney will withhold the $22,500 when the sale takes place holding the funds in Escrow until the IRS processes the 8288B. Once the IRS have processed the 8288B and provided a withholding certificate for the lower withholding amount the Settlement Agent/Attorney will distribute the funds. In the example above $18,500 of the funds would be released to the seller with the other $4,000 required withholding being sent to the IRS along with forms 8288 & 8288A.

The IRS generally take 30-90 days to process the 8288B application. 

It should be noted that the $4,000 required withholding in the above example is still considered a tax estimate and the investor is still required to file a tax return for the year of sale. 

In most circumstances the investor will receive a further refund from the $4,000 withheld tax when they complete their tax return as the actual rate of Capital Gains tax is likely to be less than the 20% applied. This is because the actual rate of Capital Gains tax under the current tax code is 

a. Zero % if you are in the 15% tax bracket or below (taxable income plus gain in year of sale less than $41,650)
b. 15% if your income plus capital gain is less than $225,000 Married Filing Separately or $400,000 Filing as Single.
c. 20% above $225,000 Married Filing Separately and $400,000 Filing as single.

In the example above if the investors other US Source income was less than $20,850 for the year they would get a full refund of the $4,000 withholding tax when they filed their tax return. 

Please note: If you have not owned the property for more than 1 year the gain will be taxed as Ordinary Income and not as a capital gain and will be subject to regular income tax rates.

Finally the sale may be subject to a claw back on depreciation that has been deducted on prior year tax returns.

Filing an 8288 & 8288A for the full 15% FIRPTA Withholding.

As an alternative to filing the 8288B and agreeing a reduced withholding amount you can instead allow the Settlement/Agent to withhold 15% of the Contracted Sales Price and pay it over to the IRS on your behalf using the forms 8288 & 8288A.

The disadvantage of this approach is that in most circumstances the amount withheld will be significantly more than your tax liability and you will not be able to claim any refund that is due until you file a tax return for the year of sale in the following year.

For example you sell a property in March 2017, you cannot claim a refund until you file your 2017 tax return, which at the very earliest will be the end of January 2018 and it will likely take a further 8-12 weeks to process the refund.

We therefore recommend the option of filing an 8288B in order to accelerate the refund process.

Please contact us if you have any questions or would like us to prepare your FIRPTA applications. 

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