FIRPTA: A Comprehensive Guide 

Real estate transactions in the United States inevitably involve taxes. When U.S. citizens sell property, they must pay capital gains taxes on any profits. Foreign investors also face potentially substantial tax bills on U.S. real estate transactions and investments. One key tax law that foreign investors may encounter is the Foreign Investment in Real Property Tax Act, commonly known as FIRPTA. Under FIRPTA, foreign persons face U.S. income taxes when they sell real estate and certain other U.S. property interests that generate gains.  

What is FIRPTA?  

The Foreign Investment in Real Property Tax Act (FIRPTA) is an essential federal tax law foreign investors in U.S. real estate must understand. Enacted in 1980, FIRPTA requires foreign persons to pay U.S. income tax on dispositions of U.S. real property interests (USRPIs). This includes direct investments in U.S. real estate and interests in U.S. corporations or partnerships that own significant U.S. real estate assets.   

Under FIRPTA, foreign sellers are taxed on gains from selling U.S. real estate, just like U.S. resident sellers. Taxes can apply at the federal and state levels. Given the complexity of FIRPTA, foreign investors must obtain proper tax and legal guidance when selling U.S. real estate. Proper planning is essential to navigate FIRPTA successfully and minimize any unexpected tax burdens.  

What Qualifies as a USRPI?  

FIRPTA has a broad definition of what counts as a USRPI. USRPIs include: 

• Direct ownership of U.S. real estate, including residential and commercial property  
• Ownership of stock in a U.S. corporation if 50% or more of its assets consist of U.S. real property interests 
• Ownership of partnership interests if 50% or more of partnership assets are USRPIs 
• Options or contracts to acquire USRPIs  
• Profits from the disposition of USRPIs 
• Ownership of assets used in real property trades or businesses in the U.S. 

When Does FIRPTA Apply?  

FIRPTA taxes are triggered when a foreign person disposes of a USRPI in a taxable transaction. The following types of transactions by foreign persons are subject to FIRPTA: 

• Selling U.S. real estate for a gain 
• Receiving certain distributions from a Real Estate Investment Trust (REIT) or real estate partnership 
• Liquidating a U.S. corporation or partnership that holds USRPIs  
• Making a gift of USRPIs 

Importantly, FIRPTA does not apply to purchases or capital investments in U.S. real estate, only to dispositions subject to capital gains tax. FIRPTA also does not apply to sales of personal residences if certain ownership and use tests are met. 

FIRPTA Tax Rates   

Under FIRPTA, foreign sellers are taxed at the same capital gains rates that apply to U.S. persons on dispositions of real property. For individuals, this could mean a federal rate as high as 20% along with the 3.8% net investment income tax (NIIT) for a top rate of 23.8%.  

For foreign corporations, FIRPTA gains are taxed at the regular U.S. corporate income tax rates, currently a top rate of 21%. When the 3.8% NIIT is included, the maximum FIRPTA rate for corporations is effectively 24.8%.  

FIRPTA Withholding Requirements  

To enforce tax payment under FIRPTA, the buyer or other withholding agent must withhold 15% of the gross sales price at closing if the seller is a foreign person. The 15% FIRPTA withholding is an estimated prepayment credited against the foreign seller's ultimate FIRPTA tax liability. If 15% of the realized gain exceeds the taxes owed, the seller can request a refund for overpayment.  

FIRPTA Exceptions and Exemptions  

Although FIRPTA has broad application, there are some notable exemptions and exceptions. For example, FIRPTA does not apply to sales under $300,000 by foreign sellers who use the property as a personal residence. Stock sales of publicly traded companies are also exempt. In addition, stock sales are exempt if the corporation owns less than 50% of USRPIs. Other exemptions apply to foreign retirement plans, charitable organizations, foreign governments, international organizations, and qualified foreign pension funds. Foreign sellers may also be exempt from FIRPTA if they are eligible for tax treaty benefits or reduced tax rates under an applicable treaty provision.   

Beyond the defined exemptions, some foreign sellers can take advantage of non-recognition provisions in the tax code to defer or altogether avoid FIRPTA taxes. If the specifics of a transaction align with the non-recognition rules, the foreign seller may qualify to defer or eliminate the FIRPTA tax that would otherwise apply. 

For transactions subject to FIRPTA, the foreign seller must report the sale to the IRS by filing Form 8288 along with payment of the FIRPTA withholding tax. The foreign seller must also file a U.S. income tax return to report the sale and pay any additional FIRPTA tax owed. On the buyer side, the withholding agent must notify the FIRPTA withholding on Forms 8288 and 8288-A when remitting the tax to the IRS. The buyer must also provide the foreign seller with a copy of Form 8288-A.  

Conclusion 

FIRPTA is a complex area of U.S. tax law that imposes income taxes on foreign investors when they sell or dispose of U.S. real property interests. While FIRPTA has broad application, there are notable exemptions and ways for foreign sellers to defer or eliminate the taxes through proper planning. Given the nuances of FIRPTA, foreign real estate investors are advised to consult with legal and tax professionals to ensure full compliance and utilize strategies to minimize their FIRPTA tax burdens when selling U.S. real estate or related U.S. property interests. Advanced planning is vital to navigating FIRPTA successfully as a foreign investor.