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LEGAL MATTERS: Foreign Sellers May Face Income Tax Liability

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By Kathleen G. Moriarty, 

Peters & Moriarty, 

Attorneys and

Counselors of Law

 

Legal Matters is a regular column intended to address general legal concerns. Since every client walks in the door with a different set of circumstances, you should not rely on this column to provide specific legal advice. If you are in need of specific legal advice, please consult with an attorney; he or she will provide advice that is unique and tailored to your legal needs.

FIRPTA, the Foreign Investment of Real Property Tax Act, in a nutshell, “encourages” foreign sellers of U.S. real property to pay their income tax when they sell real property by requiring the buyer to withhold a certain percentage of the seller’s proceeds.

In legalese, it states that the disposition of a U.S. real property interest by a foreign person (the transferor) is subject to income tax withholding.

In English, and in the context of the Ellicottville real estate market, a “disposition of U.S. real property interest” is the sale of real property, including any houses or other structures.

A foreign person (transferor) is any nonresident alien individual, foreign corporation, foreign partnership, foreign trust or foreign estate. A resident alien individual is not a “foreign person.”

The withholding is 10 percent of the purchase price if the foreign person is an individual; special rules apply to corporations and other legal entities.

Although the IRS is interested in collecting the seller’s income tax, the buyer is the party required to withhold the 10 percent. Thus, it is the buyer’s responsibility to determine whether the seller is a foreign person, and a buyer who fails to withhold may be held liable for the tax. Typically, the buyer is not burdened with the actual withholding; his attorney or another withholding agent is.

The withholding is particularly harsh for the seller when the deal is closed early in the year, since he must wait until the next calendar year to file his tax return. For example, if the sale takes place in February 2013, the seller will not be able to file his income tax return until at least January 2014. Assuming the IRS determines that a refund is due, the seller may not receive a check for weeks.

As most laws do, FIRPTA carries a few exceptions, the most common of which occurs under the following circumstances:

The buyer acquires the property for use as a home;

The purchase price is not more than $300,000; and

The buyer plans to reside at the property for at least 50 percent of the number of days the property is used by any person during each of the first two 12-month periods following the date of transfer.

This exception is responsible for the FIRPTA Affidavit that many buyers and sellers have, or will, become familiar with. If the sale meets the criteria above, then the seller’s attorney will ask the buyer to sign the FIRPTA Affidavit so that the seller’s proceeds are not subject to withholding.

Fortunately, many properties sold in Ellicottville fit this exception and the seller avoids withholding.

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