Many homes in South Florida are owned by residents of Canada, the United Kingdom, Europe or the Caribbean Islands. When these owners who hold title in their own names go to sell they often run afoul of a federal law known as the Foreign Investment in Real Property Tax Act, commonly known as FIRPTA. FIRPTA is designed to prevent foreign owners from selling property in the United States and taking their profit home, outside the jurisdiction of the Internal Revenue Service to collect the tax on the gain that is due on the sale.
FIRPTA works by requiring the buyer (known as the transferee) to withhold ten (10%) percent of the sales price from the seller’s (known as the transferor) proceeds. For example, of the home being sold by a Canadian with a sales price of $500,000.00 the transferee is required to withhold $50,000.00 from the proceeds and remit same to the Internal Revenue Service within twenty days of closing. To add real teeth to the law, any realtor or title company involved must also see that the money is remitted or face penalties along with the transferee.
The biggest issue with FIRPTA in the current world is the requirement of payment of withholding even if the seller has an obvious loss. For example, if the seller in the transaction described purchased the property in 2004 for $750,000.00, they would have a loss of $250,000.00 and no tax on the sale would generally be due. Even though they have the loss, they will have to have the money withheld, and the only way to get the money back is to either apply for a withholding certificate or wait until the next year and file a 1040NR showing the loss (which will result in a refund).
Compounding this problem is the fact that many sellers are partially or wholly underwater. Typically, a $500,000.00 sale will net a seller only $460,000.00. If the seller owes more than $460,000.00, the seller will have to bring money to the closing to pay the withholding. If the sale is a short sale, the seller will have to pay 100% of the withholding to the Internal Revenue Service. This is money that many sellers simply cannot afford, resulting in more foreclosures.
There are two exemptions to the requirement for withholding. The first exemption is for residential sales under $300,000.00. This exemption is conditioned upon the buyer purchasing the home or a member of their family must have definite plans to reside at the property for at least fifty percent of the number of days the home is used by any person during each of the first two annual periods following the date of sale. If the buyer will sign an affidavit to that effect, no withholding is required, even of the seller has a taxable gain on the sale. Please note that even if the exemption is met, the seller is still liable for the payment of any tax due on the sale.
The second exemption is the acquisition of the seller of a withholding certificate from the Internal Revenue Service setting forth the amount required to be withheld. This certificate can be applied for at any time before closing. The application is designed to show the basis for the seller in the property from the original purchase, any increases in the basis for capital improvements, and the amount being realized from the sale after subtracting costs of sale. This formula is used to show if the seller, as transferor, has any taxable gain.
If the application (with supporting documents including deeds, contracts, HUD-1 closing statements and receipts) is accepted by the Internal Revenue Service, the transferor can obtain a withholding certificate showing the amount of tax due (often zero) and if obtained before closing, no withholding is required. If filed before closing, but obtained after closing, the ten percent withholding can stay in escrow with the closing agent and then be released in whole or in part upon presentation of the withholding certificate to the closing agent.
The FIRPTA withholding is a very costly issue for many sellers. Next month I will discuss ways to avoid withholding by proper planning when purchasing Florida real estate.