Non-Resident Aliens and the Sale of U.S. Real Property

Introduction

The relatively weak value of the U.S. dollar, the stability of the U.S. political system, and the comparatively low price of real estate, among other reasons, attract significant foreign investment in U.S. real property. However, non-resident aliens (NRAs) should be aware of certain provisions of the notoriously aggressive U.S. Internal Revenue Code (IRC). One provision that impacts foreign owners of U.S. real property interest is the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).

FIRPTA subjects proceeds from the sale of much NRA-held U.S. real property to 10% withholding at the time of closing. This imposes requirements on seller and purchaser alike, although there are ways to mitigate them. Careful planning is required in order to ensure that the mitigation strategy is properly executed and does not delay closing the deal.

Overview

FIRPTA mandates that the purchaser or purchaser’s agent is responsible for withholding and remitting 10% of the amount realized to the IRS, along with the appropriate filing. This withholding may have little or no relationship to the actual income tax due. Indeed, it can significantly exceed the income tax liability. It also does not exempt the NRA seller from filing a U.S. income tax return (generally Forms 1040NR, 1120 or 1120F). For these and other reasons, NRA sellers often seek a withholding certificate from the IRS. Such certificates are regularly and routinely issued by the IRS, although this can take some time. Additionally, there are certain limited circumstances in which withholding may not be required and, ultimately, tax may not be due.

Strategic and Practical

One of the first considerations is whether the seller is categorized as a foreign or “non-resident” investor. Even without having resident alien status under the U.S. immigration law (“green card”), it may be possible that an NRA is considered a resident alien for tax purposes under the IRC. NRAs should consult an experienced attorney, accountant or tax adviser to review their residency status for tax purposes, at the time of purchasing U.S. property or when considering the acquisition or sale of U.S. property.

The second consideration is whether the transaction itself is subject to FIRPTA withholding. There are generally four broad categories of real estate transactions that are exempt, including:

Sale of real property for less than $300,000.
A narrow category of §1031 like-kind exchanges.
Certain corporate formations.
Contributions to or distributions from a partnership.

Many people mistakenly believe that taking title to real property in a single-member limited liability company (LLC) formed specifically for the purpose of holding title to the property will shelter them from tax liabilities, including FIRPTA withholding. The IRS generally disregards such entities and treats them as indistinguishable from the sole member.

If the transaction is subject to FIRPTA, there are some actions that can save time, money and aggravation right before, during or after a sale of U.S. real property.

Ensure That Paperwork is in Order

Retain a copy of the closing report from the original purchase with all of the information so advisers can calculate the basis in the property for income tax purposes. Some closing costs can be added to the basis of the property.
Retain the withholding certificate from the original purchase. The IRS requires submission of a copy of the withholding certificate or certification that no withholding is due at the time of purchase when applying for a withholding certificate when the property is later sold.
Retain copies of receipts for major repairs/capital improvements. These costs will increase the basis of the property, and evidence of such costs is useful when the property is sold.
Obtain an ITIN (Individual Taxpayer Identification Number) and file US tax returns as may be required. Work with a tax adviser to determine if there are available tax treaty benefits.

Understand the Timing and Plan Ahead

Obtaining an ITIN has become more difficult since 2012. There are only four IRS offices outside of the U.S. for processing ITIN applications: Beijing, Frankfurt, London and Paris. Otherwise, you have to find an authorized acceptance agent to review and process the paperwork.

The ITIN process alone may take between 6-10 weeks. Even if you do not meet the threshold requirements for filing a U.S. income tax return, it is important to make sure that you have an ITIN prior to marketing the property. This can facilitate a quicker closing (30-60 days from date of contract) and simplifies the required paperwork for a FIRPTA withholding certificate.

Filing the FIRPTA withholding certificate cannot occur until there is a signed contract. This process also necessitates that all required U.S. income tax returns were filed during the prior three years. The IRS has 90 days from date of mailing to respond to the request for the withholding certificate. Closings often happen before a response has been received from the IRS. During that time, an escrow agent can hold the 10% in escrow instead of remitting it to the IRS.

Illustration

In 2009, a single, nonresident alien (“NRA”), purchased a one bedroom condominium apartment for $1,500,000. During the past five years, the NRA renovated the apartment and made capital improvements, causing the property to have an adjusted basis of $1,700,000. In 2014, the NRA sold the property and incurred closing expenses equal to 10% of the sale price. The table below presents two possibilities resulting from the sale. In the first, the seller realizes a gain of $100,000, taxed as ordinary income in the 28% bracket. In the second, the seller realizes a loss of $260,000.

Note that in both examples, required FIRPTA withholding significantly exceeds the NRA’s estimated income tax liability.

Purchase Price

Amount Basis

(Purchase + Improvement)

Sale Price

Closing Costs

Gain/Loss

FIRPTA Withholding (10% of Sale Price)

Estimated Actual Tax Due

Over/Under Payment

$1. 5 million

$1.7 million

$2 million

$200,000

$100,000

$200,000

$21,175.75

$178,824.25

$1.5 million

$1.7 million

$1.6 million

$160,000

($260,000)

$160,000

Applying to the IRS and obtaining a withholding certificate can reduce or alleviate the 10% withholding required by FIRPTA. By planning ahead, having your paperwork in order and consulting with knowledgeable attorneys and tax advisers, an NRA can prevent FIRPTA from being an unexpected surprise.