The Foreign Investment in Real Property Tax act, universally called FIRPTA, is a complicated piece of tax law that applies to foreign companies and investors when they sell real estate investments in the United States.
Because FIRPTA taxes can be high—often more than 30 percent—it pays to understand who pays the taxes, how they are calculated and when the withholding rules apply. True, the specific answers will be unique to each transaction. But there are benefits to understanding the general principles, which can help in deal structure, tax planning and simply to communicate more easily with the experts you hire.
Who Pays FIRPTA Taxes?
Let’s start with the very basic question of who pays FIRPTA taxes. Payers fall into two categories: foreign corporations and what the law calls Nonresident Alien Individuals, which are foreign investors who have no U.S. citizenship. In the case of foreign corporations, the equation is relatively simple. If the corporation sells a real property interest in the U.S., then the corporation pays the taxes.
However, if that company is a partnership or an LLC and the profits from the sale are passed through to the partners, then so is the tax liability. Whether the partners are individual foreign investors or foreign corporations, those partners will pay the tax on the gain. Obviously, it is prudent to consult a tax expert prior to sale and, as you will see, to do some tax planning, because it could substantially lower the tax burden.
Calculating FIRPTA Taxes
FIRPTA taxes seller on the the “gain” from a real estate transaction, meaning the amount that the sale price (technically, the “amount realized”) exceeds the “tax basis,” meaning the capital investment in a property for tax purposes (usually the original purchase price plus improvements less depreciation). For example, let’s say that a foreign corporation owns a building in the U.S. and agrees to sell it for $10 million and its tax basis was $2 million. The taxable gain would be $8 million.
However, there are ways to lower taxable gains for those who engage in tax planning. One opportunity is to sell multiple properties. FIRPTA law allows sellers to pay taxes on the net gains for a year, meaning that properties sold at a loss can offset the gain from properties sold for a profit. For example, let’s say a foreign company sells two buildings. One is sold for a $5 million gain, but the other is sold for a $2 million loss. Only the remaining $3 million net gain would be subject to FIRPTA taxes.
Tax Rates and Withholding
FIRPTA tax rates are determined by who is selling, with foreign corporations and foreign investors taxed at different rates. Foreign corporations are subject to the same tax rates as U.S. corporations, which means the regular flat rate of 21 percent established by the new tax law Congress passed in late 2017. Individual foreign investors are subject to the same rates the U.S. uses to tax individuals, with a maximum rate of 37 percent. The level of income and gains subject to that top rate will vary according to each person’s individual tax situation.
Gains that are taxable under FIRPTA are subject to immediate withholding, meaning that the taxes must be withheld from the proceeds of the sale at the time of the transaction and remitted to the IRS. The seller cannot wait until filing a tax return in April. If the amount withheld is greater than the taxes owed, the seller can seek a refund when tax returns are filed.
Overall, a little knowledge of FIRPTA law goes a long way. Tax planning might dictate when properties are sold, how many properties are sold and other variables that could add up to large tax savings. To learn more, download our guide, Taxation of Foreign Investments in U.S. Real Estate. It’s free and provides a complete primer on the basics of FIRPTA law.
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