At a tax conference panel on tax strategies for foreign investments in US real estate, a pair of practitioners shared insights on navigating certain pitfalls when advising clients in transactions involving the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).
As explained on an IRS webpage, FIRPTA applies to dispositions of US real property interest (USRPI) held by a non-US person. The purchaser, or transferee, buying from a foreign person must withhold 15% of the amount realized on the disposition, which is the sum of the principal, the fair market value, and any assumed liability upon transfer. Foreign corporations distributing USRPI must withhold 21% of the gain recognized on distributions to foreign shareholders. The onus is on the buyer to ensure the IRS can collect the withholding tax.
Karlin & Peebles Partner Michael Karlin, who co-presented a panel November 13 alongside Greenberg Glusker Partner Thomas Giordano-Lascari at a New York University tax conference in Berkeley, California, said the definition of a USRPI is “very broad.”
“It’s basically any interest in the real property other than as a creditor,” Karlin explained.
The IRS added that the definition “also means any interest, other than as a creditor, in any domestic corporation unless it is established that the corporation was at no time a U.S. real property holding corporation during the shorter of the period during which the interest was held, or the 5-year period ending on the date of disposition (applicable periods).” Or, as Karlin cautioned, if a taxpayer meets the 50% test, then they are “tainted for five years.”
The withholding agent, most often the transferee, completes a Form 8288 U.S. Withholding Tax Return for Certain Dispositions by Foreign Persons, which is accompanied by a statement, Form 8288-A. Karlin and Giordano-Lascari stressed it is “critical” for the transferor to have a taxpayer ID number because the IRS often struggles with matching withheld tax to taxpayers. However, in their experience it is often the case that transferor clients come in at the last minute before closing without a Social Security number or an ITIN.
“Sometimes you can work with escrow to hold it in escrow funds while you try to apply for a withholding tax certificate or you apply for an ITIN for the client so that it can be tracked,” said Karlin. “But some with escrow agents are more sophisticated than others. Some just want to pay the tax and be done. And it can be very challenging, especially when after the fact you’re trying to go back and get that refund.”
“[E]ven worse,” Giordano-Lascari said, is when there is an ITIN (or EIN for a corporation) and everything is in order with the tax withholding, but the IRS nonetheless sends a penalty notice because they couldn’t match the payments. “And six months later, you’re still arguing with them and then there are levies being threatened … This has happened to me more than once.”
He advised practitioners to “absolutely make sure that you’ve got evidence that the escrow agent or whoever was doing nothing has in fact, actually paid the money over. Make sure that the way they do it involves certified mail so that they can prove that the payment was made. Make sure that everything gets done as punctiliously as possible.” According to Giordano-Lascari, the IRS “isn’t set up for this.”
As Karlin alluded to previously, one FIRPTA withholding exception involves the transferor obtaining a withholding certificate using Form 8288-B to take the position that the gain is far less than the amount realized, or even resulted in a loss. The certificate application essentially seeks permission to lower the tax, or not apply it at all.
“The problem is: if you get it within six months, you’re lucky,” said Karlin. “Some of them have been even longer, but theoretically, it is possible to get a reduced withholding tax certificate, produce it in closing, and then avoid the over-withholding. But it’s just not an area where there’s a lot of resources, from my experience.”
Giordano-Lascari recommended paying anyway and seeking a refund the next filing season to put the ball in the IRS’ court because the agency is more likely to issue a refund before it starts to bear interest than it is to respond to a withholding certificate application within the 90-day window.
The IRS is “not fast at all,” he said, “so you may actually be better off letting the tax get paid because at least now the burden is on the government.”
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