FIRPTA is by far my favorite tax subject to discuss. It is a major law for everyone in the tax field, but very little people know how to plan around or even deal with the compliance aspect of it. For an even further dive, you can check out my CLE on the State Bar of Texas International Tax site and for CPE earner, my course can be accessed through WebCE portal. This blog is to help you in identifying where FIRPTA will arise, and to check with a qualified CPA or tax attorney for staying compliant.
The best way I have found to explain FIRPTA is through an example. Assume Susie is a foreign resident. She visits the US, but she does not reside in the US. Loving the US economy, Susie would like to invest in the US, and she decides to purchase a building--The Sue's Apartment building. Susie spoke to a tax professional who informed her that foreign nationals are not typically taxed on capital gains if they own stocks. Thus, Susie sets up a US corporation, Susie Co., to hold the building.
After 7 years, Susie sold her stocks in Susie Co. With a basis of $1M, Susie received $1.5M for the disposition. Thus, Susie realizes a gain of $500,000. Although the general rule is that foreign nationals are typically not taxed on their capital gains from the disposition of stocks, this rule does not apply when US real property interest are part of the transaction.
FIRPTA reclasses non-taxable gains to taxable gains, and it does it through withholding. Thus, Susie’s $500,000 realized gain must be recognized, and Susie is taxed on that gain. Because Susie does not reside in the US, there’s a good chance the IRS might not ever be able to collect the gain on $500,000 from Susie. Thus, FIRPTA implemented a withholding regime.
Buyers are required to withhold 15% of the sales price and remit that proceed to the IRS, unless a withholding certificate applies to lower or eliminate the withholding. If the buyer fails to withhold, he then becomes liable to the IRS for the tax.
Back to our example, 15 percent of $500,000 equals $225,000. If Susie is in the 35% tax bracket, her tax would have been $175,000, $50,000 less than the withholding. If Susie were a US citizen, the amount of tax would be dramatically lowered since there is a preferred rate for capital gains tax.
For FIRPTA to apply, you'll need 3 elements: (1) a foreign person, (2) who realizes a gain from the disposition (3) of a US real property interest.
(1) a foreign person includes
Nonresident alien individual (“NRA”)
Foreign trust and estate, and
Other foreign entities that is not a U.S. person.
(2) disposition is very broad and may include
Gifts in which the adjusted basis of property transferred is less than the liabilities transferred;
Changes in an interest in a partnership, trust, or estate;
Capital contribution, distribution, liquidation, or redemption;
Common distributions include: a distribution by a domestic subsidiary to a foreign parent when the distribution exceeds earnings; a transfer by a foreign parent of shares of a domestic subsidiary to a foreign subsidiary; or when a foreign parent has a foreign subsidiary make a check the box election and the foreign subsidiary itself has a domestic subsidiary.
Corporate reorganizations, mergers, or liquidations;
(3) US real property interest includes
any interest, other than an interest solely as a creditor, in either:
Real property located in the United States or the Virgin Islands, or
a domestic corporation unless it is established that the corporation was not a U.S. real property holding corporation during the shorter of:
the period after June 18, 1980, during which the taxpayer held such interest, or
the 5-year period ending on the date of the disposition of such interest.
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