March 8, 2017

Realtors with Foreign Clients: US FIRPTA Withholding Tax Guidance (Part 2), Withholding Certificate Exception and Early Refund Alternative

US FIRPTA Withholding Tax Guidance (Part 1) sent to you previously explained the “residence exemption” that is potentially available to your foreign clients to avoid FIRPTA withholding tax on their US real estate sale.

Another procedure, known as an IRS “application for withholding certificate”, can potentially eliminate, or at least reduce, the amount of FIRPTA withholding tax.

APPLICATION FOR WITHHOLDING CERTIFICATE

If the amount of the FIRPTA withholding tax (generally 10% or 15% of the selling price) will exceed your client’s “maximum US tax liability”, your client can apply to the IRS for a withholding certificate to reduce, or waive, the withholding, down to the maximum US tax liability.

If the application is filed by the day of closing, the closing agent will retain the FIRPTA withholding tax in escrow until the IRS response (the withholding certificate) is received. When the certificate is received, the tax withheld is refunded to your client by the closing agent, in accordance with the instructions in the certificate - i.e most, or all, of the FIRPTA withholding tax is refunded to your client. This process can be completed in about 3 months. Otherwise, under normal procedures, and current IRS restrictions, your client could wait a year, or longer, to receive the refund.

MAXIMUM US TAX LIABILITY

The maximum US tax liability is not your client’s actual tax liability. It is simply a temporary calculation of the maximum US tax rate, multiplied by the amount of profit. For individuals with long term gains, this maximum tax rate is 20%. For most individuals, the actual long term gains rate will less than 20%. Therefore, after the end of the tax year, your client will file a US tax return, and possibly obtain a further refund, in addition to the withholding certificate refund.

The application for the withholding certificate must also demonstrate that your client properly addressed FIRPTA withholding tax at the time of his/her purchase of the real estate.

Example:

David and Abby (husband and wife) are foreigners (nonresident aliens) selling their US real estate for $400,000, which they have jointly owned for 5 years. If the previously described residence exemption does not apply, the FIRPTA withholding tax would be $60,000 (15% of $400,000). Therefore, David and Abby wish to file an application for withholding certificate to reduce the withholding.
 

Assume details as follows:

Present selling price

400,000

Selling expenses

(32,000)

Net Proceeds

368,000

Original purchase price

275,000

Improvements

75,000

Total Cost

350,000

Gain

18,000

“Maximum US tax” (20%)

3,600

By the day of closing, David and Abby will file an application for withholding certificate with the IRS, documenting the above information, and demonstrating that FIRPTA withholding was addressed at the time of their purchase of the property. At the time of closing, $60,000 FIRPTA tax will be withheld from David and Abby’s proceeds, and held in escrow by the closing agent. Approximately 3 months after filing the application, assuming the IRS agrees with its contents, the IRS will issue a withholding certificate instructing $3,600 to be sent to the IRS and the balance of $56,400 to be refunded directly to David and Abby. Depending on other factors, David and Abby may later be entitled to a full refund of the remaining $3,600 on their US income tax returns.

EARLY REFUND ALTERNATIVE

Suppose David and Abby do not file the application by the day of closing. In this case, the $60,000 FIRPTA withholding tax must be sent to the IRS by the closing agent. But David and Abby can still obtain an early refund of the $56,400 from the IRS, by requesting a refund using the same withholding certificate application procedure described above. In this case the $56,400 refund would come from the IRS, instead of from the closing agent, and in many cases would come sooner than waiting until the end of the tax year, to claim the refund on the income tax returns.

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