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.
