Understanding the 15% FIRPTA Tax: A Crucial Guide for Foreign Property Owners

Imagine this scenario: You’ve just sold your US property, expecting a significant profit. But instead of celebrating, you are shocked as a large portion of your proceeds is withheld due to the 15% FIRPTA tax. This unexpected deduction leaves you scrambling to understand why a significant chunk of your sale price has vanished and what steps you should have taken to avoid this situation. This unfortunate scenario is all too common for foreign sellers of US real estate who are unfamiliar with the 15% FIRPTA tax.

FIRPTA is 15% of the sales price, not the profit of selling US real estate property

The Foreign Investment in Real Property Tax Act (FIRPTA) requires foreign persons selling US real estate to pay a withholding on the gross sales price. As of recent regulations, the withholding rate stands at 15% of the sale price, not just the profit. This applies to non-U.S. residents and entities, making it a significant consideration for anyone from abroad looking to buy or sell property in the United States.

The key issue with the 15% withholding is that it is based on the total sales price, not just the profit made from the sale. This means that even if you sell at a loss, the IRS still requires 15% of the total sale amount to be withheld. The idea behind this is to ensure that foreign sellers pay US taxes on any gains derived from US real estate, but applying this law can feel quite harsh to those unfamiliar with the US system.

It’s crucial to understand that this 15% withholding is not necessarily the final amount of money you owe. You may be entitled to a refund if the liability is less than the withheld amount. However, to recover any excess withholding, you must file a US 1040 return, which can be a complex and time-consuming process, especially for those unfamiliar with US law.

Exemptions

One of the biggest challenges with the 15% FIRPTA tax is navigating the various exemptions and reductions that may apply. For example, if the buyer uses the property sold as a primary residence and the sale price is under $300,000, the withholding may be reduced to 0%.

Additionally, if you anticipate that your actual liability will be lower than the 15% withheld, you can apply for a withholding certificate from the IRS to reduce the withheld at the time of sale. However, these options require advance planning and a thorough understanding of US laws.

The consequences can be severe for those who fail to plan ahead. Without a professional’s proper knowledge or guidance, foreign sellers can find themselves paying far more than necessary in taxes or, worse, facing penalties for non-compliance. The IRS takes FIRPTA very seriously, and failure to comply can result in interest charges and additional fines.

Get professional advice

Working with a tax advisor who understands the intricacies of US real estate transactions for foreign sellers is essential. They can help you determine if any exemptions apply, assist in applying for a withholding certificate, and ensure that your US 1040 return is filed correctly to recover any overpayment.

US & overseas liabilities

In addition to understanding FIRPTA itself, foreign sellers should be aware of the broader implications of selling US property. Depending on your country of residence, you may also be liable for taxes on the sale proceeds in your home country, such as HMRC in the UK. Tax treaties between the US and your home country may affect how much tax you ultimately owe. There is a treaty between the US & UK, and another treaty between the US and Spain.

For example, many countries have treaties with the US that allow for offsetting taxes paid in the US against your home country’s liability. Navigating these treaties can be complex, but doing so correctly can significantly reduce your overall burden.

Furthermore, the timing of your sale can impact your situation. If you plan and sell at the right time, you may be able to minimise the impact or take advantage of certain benefits that would otherwise be unavailable.

Example 1: Selling a Property in California

Jane, a UK resident living in London, owns a property in California that she purchased as an investment. She decides to sell the property for $500,000.

Withholding: Jane is a foreign seller. The buyer must withhold 15% of the total sale price at closing, which amounts to $75,000 (15% of $500,000).

After the Sale: Jane receives the remaining $425,000 from the sale, with $75,000 withheld and remitted to the IRS. Jane must file a US 1040 return to report the sale. Suppose her actual liability on the sale is less than $75,000 (based on the profit, considering the property’s adjusted basis and allowable deductions). In that case, she can apply for a refund of the excess withholding.

UK Implications: Jane must also report this sale to HMRC since she is a UK resident. The UK and the US have a tax treaty, which means she may be able to offset the US tax paid against her UK liability. However, she must follow the correct procedures to avoid double taxation.

Example 2: Selling a Property in Florida

Tom, another UK resident living in London, owns a vacation home in Florida. He decides to sell the property for $300,000.

Withholding: Tom is subject to the 15% withholding. The buyer must withhold 15% of the sale price, which amounts to $45,000 (15% of $300,000).

After the Sale: Tom receives $255,000 from the sale, with $45,000 withheld for FIRPTA. Tom must file a US 1040 return to determine his actual liability. If the tax owed is less than $45,000, Tom can claim a refund for the difference.

UK Implications: Tom must report the sale to HMRC as a UK resident. The UK and the US treaty allows Tom to claim a foreign tax credit for the US taxes paid. This helps to reduce or eliminate his UK liability on the same income, ensuring that he is not taxed twice on the gain.

In both examples, the key points are:

FIRPTA Withholding: Both Jane and Tom are subject to the 15% withholding on the sale price of their US properties, which must be paid at the time of sale.

US 1040 Return: They both need to file a US 1040 return to report the sale and calculate their actual liability. They can claim a refund if the withheld amount exceeds the actual money owed.

UK self-assessment Reporting: UK residents must also report these sales to HMRC. The US-UK treaty allows them to offset the US tax paid against their UK liability to avoid double taxation.