FAQ: Foreign Persons Buying U.S. Real Estate
1. What is FIRPTA and how does it affect a foreign individual buying U.S. real estate?
FIRPTA stands for “Foreign Investment in Real Property Tax Act.” Enacted in 1980, the law allows the United States to impose withholding income tax on foreign persons disposing of U.S. Real Property Interests. Per the Internal Revenue Service, a U.S. Real Property Interest (USRPI) is defined as “any interest, other than solely as a creditor, in real property located in the United States or the U.S. Virgin Islands, including leases and stock in U.S. Real Property Holding Corporations (US RPHC) as well as certain personal property that is associated with the use of real property (such as farming machinery or hotel furniture).” In general, FIRPTA imposes a tax of 1% – 15% of the property’s gross consideration on any foreign person disposing of a USRPI. This tax is required to be withheld by the buyer of the property, who is generally the withholding agent, and sent to the Internal Revenue Service. The withheld tax is required to be paid within 20 days of the disposition.
2. Are there any exemptions to FIRPTA?
Yes, there are exemptions to avoid FIRPTA or to reduce the amount required to be withheld. For instance, if the property being purchased is to be used as a residence and the purchase price is $300,000 or less, FIRPTA would not apply. Another exception is when the purchaser receives a certificate, under the penalty of perjury, from the seller stating that the seller is not a foreign person. Another instance of exemption is when the buyer receives a withholding certificate from the IRS that excuses withholding or reduces the amount of withholding below the required 15% of the purchase price. Such an exemption, procured by the filing of Form 8288-3, must be addressed no later than the closing date of the sale.
3. What type of expenses can a foreign person use to offset the rental income earned from investing in U.S. real estate?
Expenses directly related to the rental activity will be deductible. For example, real estate taxes, depreciation, mortgage interest paid, condo maintenance fees, repairs, insurance, utilities, etc. If the property is owned by a foreign individual or foreign entity, the owner may elect to treat the passive rental income as “effectively connected” with a U.S. trade or business. This election must be attached to a timely-filed income tax return. If this election is not made, the Investor will lose all current deductions related to the rental activity (unless the owner is actually engaged in a U.S. trade or business with such real estate).
4. What happens if I use the property partly as a rental property and partly as a vacation home?
If the property is used for 14 days or more as a vacation home and the rest of the time rented to others, the foreign investor must prorate expenses incurred and split the activity between personal and rental. The proration should count the number of days the property is used as a rental property separately from the number of days the property Is used for personal use. The resulting percentage is then multiplied by the expenses incurred on the property. Expenses related to personal use are either limited or non-deductible.
5. What is the optimal structure for a foreign person buying a property in South Florida?
Unfortunately, there is no “one size fits all” solution that addresses every client or investor’s needs. Every investor Is different in terms of circumstances, goals, and priorities. Some clients who are not overly concerned with estate taxes opt for a much simpler structure whereby the USRPI is owned by a multi-member LLC, which may not provide complete estate tax protection. Foreign persons buying property in the U.S. should consult with a tax professional as an Integral part of the purchase process.
6. Is it possible for a foreign person to defer the gain from the sale of a U.S. Real Property Interest (USRPI)?
Yes. A foreign person who owns investment property may engage in a simultaneous like-kind exchange whereby the gain on the sale of the property is rolled into the purchase of another investment property.
A delayed like-kind exchange (as opposed to a simultaneous one) is a detailed process, requiring several tax forms to be filled out (and approved by the IRS). Time constraints are a factor as the new investment property (which the seller is purchasing) must be identified within 45 days of the closing of the original property and acquired within 180 days of the closing date of the original property. FIRPTA withholding is required in a delayed like-kind exchange.
Details on how to enter into an IRC Section 1031 exchange should be discussed with a real estate attorney or tax professional.
7.Am I required to obtain an ITIN (Tax Identification Number)?
Generally, a foreign individual or entity will need an ITIN if he sells the USRPI and is required to file a tax return to either obtain a refund or to pay additional taxes owed. An ITIN will also be required for rental property or when the foreign person intends to transfer the property into a structure using a non-recognition provision.
We strongly advice potential buyers-sellers-investors to seek professional advice on this matters with proper certified professionals.