Foreign Notion – Can a Buyer be Liable for the Seller’s Income Tax?

Contracts for the purchase or sale of real property in New York invariably include a provision that requires the seller to deliver a so-called “FIRPTA” affidavit to the purchaser at closing.  Often times, the parties are not familiar with the requirements surrounding the FIRPTA affidavit.  However, in today’s market, with the ever growing presence of foreign real estate investors and developers, it is imperative that real estate buyers and sellers understand the implications of the FIRPTA requirements.

FIRPTA stands for the “Foreign Investment in Real Property Tax Act” of 1980 (the “Act”).  Pursuant to US tax law, all persons, whether foreign or domestic, must pay income tax on sales of U.S. real property interests.  Domestic persons are subject to this tax as part of their regular income tax, but foreigners are not.  As such, the Act was passed to address how foreign sellers pay this income tax.  In order to ensure that foreign sellers pay the tax, the Act requires purchasers of real property to withhold 10% of the full sales price.   If the seller is a foreign corporation, the percentage increases to 35%.

Under the Act, a foreign person is a nonresident alien individual, foreign corporation that has not made an election under the tax law to be treated a domestic corporation, foreign partnership, foreign trust or a foreign estate.  It does not include a resident alien individual.

There are a few exemptions under which a seller may be exempt from FIRPTA, including:

1. If the purchase will  be used as a residence for a price $300,000 or less;

2. If the purchaser receives a statement from the seller that the seller is a not a foreign person;

3. If the purchase is of an interest in a non-publicly traded domestic corporation where the corporation provides the required affidavit; or

4. If the purchase is of shares of a publicly traded corporation.

The most common method of ensuring the purchaser that the seller is not a foreign person, and relieving the purchaser of the FIRPTA withholding, is by the seller’s delivery to the purchaser of an affidavit commonly called the “FIRPTA affidavit”.

If it is determined before closing that the seller is a foreign person, the buyer must report and pay over any tax withheld using IRS form 8288 and 8288-A.  In most cases, this must be done by the 20th day of the transfer.  When a title agency is involved in the transaction, the agency can verify the seller’s status and oversee the necessary paperwork.   If the transferor is a foreign person and the buyer fails to withhold the tax, that buyer may be held liable for the tax.  This potential exposure mandates particular attention to this often overlooked aspect of the real estate closing.

It goes without saying that a “foreign person” buying United States real estate should be aware that they will be subject to FIRPTA withholding when they eventually sell the property.

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