Foreign Investment in the U.S.: A FIRPTA Introduction

Alicea Castellanos, CPA, TEP
Published Date:
Jan 2, 2014

They love us overseas. Yes, foreign investors want to buy U.S. real estate because of the weakening dollar, but there's more to it than that: The United States offers economic and legal transparency, backed by appropriate legal protections and a predictable regulatory environment. It’s no wonder that according to a 2013 survey from the Association of Foreign Investors in Real Estate (AFIRE), four of the five top global cities for investment are in the United States. But to take advantage of such desirable opportunities, investors, and the CPAs who serve them, need to familiarize themselves with the complex tax rules.

The key federal law governing such transactions is the Foreign Investment in Real Property Act (FIRPTA). Unfortunately, many investors fail to review its provisions and aren't prepared for the tax consequences. The goal here is to clarify the rules and responsibilities for the transferee, or buyer, and transferor, or seller, when non-U.S. investors buy and sell U.S. real estate.

Starting with the Basics

A foreign person will be subject to FIRPTA upon the disposition of a U.S. real property interest (“USRPI”). FIRPTA is a process put in place to ensure the collection of tax from a foreign person upon the disposition of a USRPI. The disposition of an interest in U.S. real property by a foreign person is treated as if the person was engaged in a U.S. trade or business, and gain or loss must generally be recognized on the transaction (IRC 897(a), 871(b) and 882(a)). The disposition by the foreign person is subject to tax under IRC § § § 1, 11, and 55, and the transferee (buyer or his agent) must usually withhold tax and submit the appropriate tax returns (IRC 1445 and related regulations). The withholding tax is 10 percent of the net proceeds, typically the sales price less any sales commissions. However, treaty exceptions may apply. Note that the withholding obligation is on the buyer or his agent and not on the foreign seller. This is because it is easier for the IRS to collect from someone with a U.S. connection.

Definitions are important here. For purposes of this law, a foreign person includes nonresident aliens (“NRA”), foreign corporations that have not made an election to be treated as a domestic corporation for FIRPTA purposes (i.e., IRC 897(i) election), foreign partnerships, foreign trusts and foreign estates.

U.S. real property interest also has a specific meaning: As explained in IRC 897(c)(1); (c)(2); (c)(3); (c)(4), it means any interest in real property and associated property located in the U.S. or the Virgin Islands; and any interest in a domestic or foreign corporation defined as a U.S. real property holding company. A U.S. real property holding company (“USPHC”) is defined as a domestic or foreign corporation that has U.S. real property interests that equal or exceed 50 percent of the total fair market value of its U.S. and foreign real property and any other assets used in a trade or business. There is an exception for stock regularly traded on an established securities market. Assets held by a partnership, trust, or estate are treated as being held proportionately by its partners or beneficiaries.

Withholding Requirements

The 10 percent withholding rule, noted above, and explained in IRC 1445(a), generally applies regardless of the amount of gain (or loss) of the foreign seller. The amount realized is the net proceeds and includes cash, fair market value of other property and liabilities assumed by the buyer or to which the U.S. real property interest is subject to.

There are exceptions to the general rule (under 1445(b)): the property is acquired by the buyer for use as a residence, and the purchase price is less than $300,000; the corporate stock of the seller is regularly traded on an established securities market; a non-publicly traded corporation furnishes an affidavit that the interest being disposed is not an interest in U.S. real property, and the transferee has no knowledge that the statement is false; an NRA (individual or entity) transferor furnishes the transferee with an affidavit stating, under penalty of perjury, that he or she is not a foreign person, and provides his or her U.S. taxpayer identification number on such an affidavit; the transferee can accept such an affidavit as long as they do not have knowledge that such a statement is false; and the transferor applies for and receives a “qualifying statement” from the IRS that he or she is exempt from withholding. The IRS has 90 days from the date of receipt of the application to process a response.

The transferee has 20 days after the transfer date to file Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests, and submit the tax withheld. The IRS will return stamped copies to the transferor (and withholding agent) for attaching to the tax return at filing (Treas. Reg. 1.1445-1(c)). If the transferor was not able to obtain a taxpayer identification number by the transfer date, the transferee is still obligated to file Forms 8288 and 8288-A and submit the tax withheld by the prescribed due date.

The transferor may still receive credit for the amount of tax withheld by attaching substantial evidence of such withholding to his or her return. The 10 percent withholding is not the amount of tax, but merely a mechanism for the U.S. to ensure the collection of tax. This withholding does not relieve the seller from filing a U.S. tax return (i.e., Forms 1040NR, 1120 or 1120F). The rules are different if the seller is a domestic partnership, trust, or estate with foreign partners or beneficiaries. IRC § 1446 withholding tax applies to the effectively connected income of a domestic partnership to the extent that it is allocable to foreign partners. Non-grantor trusts and estates have a withholding obligation upon the distribution of cash or property to a foreign beneficiary. The fiduciary must maintain a special USRPI account to withhold 39.6 percent of any distributions to a foreign beneficiary up to the balance of the USRPI account. If a grantor trust has a foreign owner, the fiduciary must withhold a tax of 39.6% of the gain the trust realizes on the disposition of a USRPI, to the extent the gain is allocated to the foreign person. If a domestic trust or estate has a foreign beneficiary and disposes of a USRPI, the fiduciary may be required to withhold. (See Treas. Reg. 1.1445.5(c)(1)(iii)(A).)

Withholding Certificates: Rules and Exceptions

Withholding certificates are commonly called reduced withholding or exemption certificates. Application for such certificate is made on Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests. This form is filed when sellers claim to be entitled to a nonrecognition treatment or exemption from tax. A second reason is when sellers are certain that they have a loss or that the 10 percent withholding obligation is greater than their maximum tax liability on the gain of the sale. There is also a third instance that is less common: when the seller claims that the special installment sales rules described in section 7 of Rev. Proc. 2000-35 allowed reduced withholding. This form can be filed by an NRA or foreign corporation.

The second item, above, is especially pertinent to many taxpayers. For this claim, the filer has to attach a calculation of the maximum tax liability showing a tax liability upon the sale of the property of zero or an amount lesser than the 10% withholding obligation, sales contracts showing the amount of sale (or an appraisal, if there's no contract) and either a closing statement, HUD Settlement Statement or Sales Contract showing original cost of property, in addition to any receipts showing improvements made to the property (IRC 897(j).

Form 8288-B needs to include tax identification numbers for all parties involved, otherwise it will be rejected. However, if the transferor is applying for an ITIN, the phrase “Applied for ITIN” should be used as an identification number. Form 8288-B should be attached to a complete ITIN application and sent to the ITIN Operation in Austin, Texas. Although either the buyer or seller can file this form, it is typically filed by the seller or the seller’s agent. The withholding agent on line 4a of the form should be the buyer or the buyer’s agent. It is recommended that the address where you want the withholding certificate sent is a U.S. address for ease of delivery and tracking. This address does not need to be the same as the transferor’s (line 1) or transferee’s address (line 2). If interest of a USRPHC is being transferred, the submission must include a share certificate showing the percentage ownership of the foreign seller of the USRPHC.

Foreign Person’s Tax Filing Requirements

NRAs who have a direct investment in U.S. real property must generally file income tax returns, except where they are engaged in a U.S. trade or business and the fair market value of the U.S. real property does not exceed $50,000. In addition, any person subject to IRC § 897(a), as noted above, or IRC § 1445 (withholding of tax on dispositions of U.S. real property interest) must pay the required tax and file a return (IRC 6039C(a), (b) and (d)). Dispositions that are taxable events are broadly defined and include the following: Sales, exchanges, distributions, tax-free exchanges, certain gifts, and so forth, of USRPIs; sales of interests in partnerships, trusts, and estates that have USRPIs (IRC § 897(g)); and contributions to capital of a foreign corporation (IRC § Section 897(j)).

The following transactions generally are not taxable since U.S. tax is only deferred and not avoided:

  • A distribution of a USRPI by a foreign corporation in liquidation or otherwise, if the distributee would be subject to U.S. tax on a subsequent disposition of the USRPI and there has been no tax-free increase in the tax basis of the USRPI (IRC § 897(d)).
  • An exchange of a USRPI in a nonrecognition transaction for another ownership interest if the subsequent sale of such interest would be subject to U.S. tax and there has been no tax-free increase in the tax basis of such ownership interest (IRC § 897(e)).

The 10 percent FIRPTA withholding will be credited toward the ultimate tax liability and the difference will be refunded to the foreign person, unless the withholding was not sufficient to satisfy the tax. Early refunds of excessive withholding tax can also be obtained by filing a tax return as soon as possible, if the taxpayer has no other income to report on the U.S. tax returns. If this is desired, prior year tax return forms can be used to file a return for the current year as long as the prior year is crossed out and marked as the current year. If filing a final corporate return, taxpayers should include the words “Final Tax Return” at the top of the return.

The gain deriving from the sale of a USRPI under IRC § 897 is considered to be effectively connected income (“ECI”). In general, the 30 percent branch profits tax applies to a foreign corporation’s effectively connected earnings and profits. However, there is an exception under 1.884-2T if the foreign corporation “completely terminates” all of its U.S. trade or business. In order to be considered to have “completely terminated” the U.S. trade or business for purposes of this exception, the following three prongs must be satisfied:

1. The foreign corporation has no assets used in a U.S. trade or business as of the close of the year.
2. Neither the foreign corporation or a related corporation uses any of the assets of the terminated U.S. trade or business or earnings and profits earned by the foreign corporation in the year of the termination in the conduct of a different U.S. trade or business for a period of three years past the close of the taxable year in which the termination took place.
3. The foreign corporation has no ECI during the period of three years past the close of the taxable year in which the termination took place.

This last item is especially relevant if foreign investors have plans to purchase U.S. real estate property at a future date and do not intend to dissolve the foreign corporation. If, however, corporate dissolution is chosen, in addition to filing the corporate return (i.e., Form 1120-F), they will need to file Form 966 – Corporate Dissolution or Liquidation required under IRC § 6043(a) and attach a certified copy of the resolution or plan of liquidation and dissolution and all amendments or supplements not previously filed.

Taxpayer Identification Number (“ITIN”)

NRAs who have never filed a U.S. tax return or are unable to obtain a social security number must get a “individual taxpayer identification number” by filing Form W-7 with the Internal Revenue Service. An ITIN will be needed in order to file for a reduced withholding certificate on Form 8288-B and / or in order to file the required return if they are to receive a credit for overpayment of taxes. If an ITIN application is filed for the purpose of reporting the sale of a USRPI on Form 1040NR, then box “b”—Nonresident alien filing a U.S. tax return—should be checked off. When filing Form W-7, it should be the first form, followed by the certified or apostilled passport copy, and then attach the Form 1040NR, including Copy B of Form 8288-A which was stamped (typically in red) by the IRS. Copy B of Form 8288-A is proof of withholding.

If an ITIN application is filed for the purpose of applying for a reduced withholding certificate on Form 8288-B, then box “h” Other - Exception 4 – Disposition by a foreign person of U.S. real property interest – third-party withholding should be checked off. Again, when filing Form W-7, it should be first, followed by the Form 8288-B, including any schedules attached to it (discussed above). It is recommended that the applicant’s mailing address on Line 2 be a U.S. address for ease of delivery and tracking of the ITIN assignment letter. Passport certifications of the issuing agency need to be in English, but Apostilles are acceptable in the foreign language. It takes the IRS about 6 to 10 weeks to process an ITIN application.

If one or more parties involved are foreign corporations and do not have an EIN, they can simply apply for one by filing Form SS-4.

Alicea Castellanos, CPA, TEP, is a manager in the international tax services—private wealth group at Prager Metis CPAs LLC. She specializes in U.S. tax planning and compliance for foreign individuals with U.S. source income, foreign individuals residing in the United States, foreign persons investing in U.S. real property, U.S. persons residing abroad and foreign trusts with a U.S. connection. She can be reached at (212) 972-7555 x251 or

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