WHAT TAX CONSEQUENCES WILL A FOREIGN PERSON ENCOUNTER WHEN INVESTING IN U.S. REAL PROPERTY?
The issue of whether a foreign person who disposes of or transfers a United States real property interest is subject to any federal income tax reporting and/or withholding requirements is, surprisingly, a question that continues to confound and perplex even the most seasoned and experienced attorneys practicing real estate law today. The following article will, hopefully, clarify and resolve the uncertainties that frequently plague legal professionals when they are asked to explain the potential tax consequences that may arise from the sale of a real property interest by a foreign person.
The sale or disposition of a real property interest by a foreign person is subject to income tax withholding. The Buyer or transferee acts as a withholding agent and must deduct and withhold a tax equal to 10% of the total amount realized on the sale or disposition. If the Seller or transferor is a foreign person and the Buyer or transferee fails to withhold, such transferee may be held liable for the tax.
A foreign person is defined as a non-resident alien individual or foreign corporation that has not made an election under Section 897 (i) of the Internal Revenue Code to be treated as a domestic corporation, foreign partnership, foreign trust or foreign estate. It does not include a resident alien individual.
The term transferor means any foreign person that disposes a real property in the United States by Sale, Exchange, Gift or any other transfer. A transfer includes distributions to shareholders of a Corporation, Partners of a Partnership and beneficiaries of a Trust or Estate.
The term transferee means any person, foreign or domestic, that acquires a US real property interest by purchase, exchange, gift or any other transfer.
The amount realized by the transferor is the sum of: (1) the cash paid, or to be paid (principal only); (2) the fair market value of other property transferred or to be transferred; and (3) the amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.
The term US Real Property Interest means an interest other than as a creditor in real property located in the United States or in the Virgin Islands as well as certain personal property that is associated with the use of real property. It also means any interest other than as a creditor in any domestic corporation, unless it is established that the corporation was at no time a US real property holding corporation during the shorter of the period during which the interest was held or the five year period ending on the date of disposition.
Withholding is required on certain distributions. However, the Buyer or transferee does not have to withhold under certain circumstances. Such circumstances include the following:
(1) the Buyer or transferee acquires the property for use as a home and the amount realized (sales price) is not more than $300,000. The Buyer or transferee or a member of such transferee's family must have definite plans to reside at the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the date of transfer. When counting the number of days the property is used, the Buyer or transferee must not count the days the property will be vacant.
(2) The transferor gives the Buyer or transferee a certification stating, under penalties of perjury, that the transferor is not a foreign person and containing the transferor's name, US taxpayer identification number, and home address (or office address, in the case of an entity).
(3) The Buyer or transferee receives a withholding certificate from the Internal Revenue Service that excuses withholding. See Withholding Certificates in IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Corporations.
(4) The transferor gives the Buyer or transferee written notice that no recognition of any gain or loss on the transfer is required because of a no-recognition provision in the Internal Revenue Code or a provision in a US tax treaty. The Buyer or transferee must file a copy of the notice by the 20th day after the date of transfer with the Internal Revenue Service Center, PO Box 21086. Drop Point 8731 FIRPTA Unit, Philadelphia, PA 19114-0586.
(5) The amount the transferor realizes on the transfer of a US real property interest is zero.
(6) The property is acquired by the United States, a US state or possession, a political subdivision or the District of Columbia.
(7) The grantor realizes an amount on the grant or lapse of an option to acquire a US real property interest. However, the Buyer or transferee must withhold on the sale, exchange, or exercise of that option.
The certification in item (4) is not effective if the Buyer or transferee has actual knowledge, or receive a notice from an agent, that it is false. If the Buyer or transferee is required by regulations to furnish a copy of the certification to the IRS and such transferee fails to do so in the time and manner prescribed, the certification is not effective.
LIABILITY OF AGENTS
If the Buyer or transferee receives the certification discussed in item (4) and the transferor's agent or the Buyer or transferee's agent has actual knowledge that the certification is false, the agent must notify the Buyer or transferee, or the agent will be held liable for the tax. The agent's liability is limited to the amount of compensation the agent gets from the transaction.
An agent is any person who represents the transferor or transferee in any negotiation with another person (or another person's agent) relating to the transaction, or in settling the transaction. A person is not treated as an agent if the person only performs one or more of the following acts related to the transaction: receipt and disbursement of any part of the consideration; recording of any document; typing, copying, and other clerical tasks; obtaining title insurance reports and reports concerning the condition of the property: or, transmitting documents between the parties.
REPORTING AND PAYING THE TAX
Transferees must use Forms 8288 and 8288-A to report and pay to the IRS any tax withheld on the acquisition of U.S. real property interests. These forms must also be used by corporations, partnerships, estates, and trusts that must withhold tax on distributions and other transactions involving US real property interests.
The tax withheld on the acquisition of a US real property interest from a foreign person is reported and paid using Form 8288, US Withholding Tax Return for Dispositions by Foreign Persons of US Real Property Interests.
Form 8288 also serves as the transmittal form for copies A and B of Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of US Real Property Interests.
Generally, the Buyer or transferee must file Form 8288 by the 20th day after the date of the transfer. If an application for a withholding certificate is submitted to the IRS before or on the date of a transfer and on the date of transfer the application is still pending with the IRS, the correct withholding tax must be withheld, but does not have to be reported and paid over immediately. The amount withheld (or lesser amount as determined by the IRS) must be reported and paid over within 20 days following the day on which a copy of the withholding certificate or notice of denial is mailed by the IRS.
If the principal purpose of applying for a withholding certificate is to delay paying over the withheld tax to the IRS, the transferee will be subject to interest and penalties. The interest and penalties will be assessed for the period beginning on the 21st day after the date of transfer and ending on the day payment is made.
Each transferor or distributee must be notified of the amount of withholding tax paid to the IRS. Form 8288-A is used for this purpose. The Buyer or transferee should attach copies A and B to Form 8288. The IRS will stamp Copy B and send it to the person subject to withholding. The Buyer or transferee should keep Copy C for his/her records.
Generally the real estate broker or other person responsible for closing the transaction must report the sale of the property to the IRS using FORM 1099-S, Proceeds From Real Estate Transactions. For more information about Form 1099-S, see the Instructions for Form 1099-S and the General Instructions for Forms 1099, 1098, 5498, and W-2G.
The amount that must be withheld from the disposition of a US real property interest can be adjusted pursuant to a withholding certificate issued by the IRS. The transferee, the transferee's agent, or the transferor may request a withholding certificate. The IRS will generally act on these requests within 90 days after receipt of a complete application.
A withholding certificate may be issued due to: (1) a determination by the IRS that reduced withholding is appropriate because either: (a) the amount that must be withheld would be more than the transferor's maximum tax liability; or (b) withholding of the reduced amount would not jeopardize collection of the tax; (2) the exemption from US tax of all gain realized by the transferor; or (3) an agreement for the payment of tax providing security for the tax liability, entered into by the transferee or transferor.
All applications for withholding certificates are divided into six basic categories. This categorizing provides for specific information that is needed to process the applications. The six categories are: (1) Applications based on a claim that the transfer is entitled to nonrecognition treatment or is exempt from tax; (2) Applications based solely on a calculation of the transferor's maximum tax liability; (3) Applications under special installment sale rules; (4) Applications based on an agreement for the payment of tax with conforming security; (5) Applications for blanket withholding certificates; and, (6) Applications on any other basis.
*The above article is based upon an article written by Joel Stein in the Massachusetts Conveyancers Association, Inc. published newsletter, Volume 21, Number 4, Fall 2002 and supplemented by independent research..
Effie N. Dikegoros
Law Office of John M. Iacoi & Associates
Lewis Wharf, Bay 215
Boston, Massachusetts 02110