FIRPTA

Key Takeaways

• FIRPTA stands for the Foreign Investment in Real Property Tax Act. Under 26 U.S.C. 1445(a) the buyer, not the seller, must deduct and withhold 15 percent of the amount realized when a foreign person disposes of a United States real property interest.
• The rate falls to 10 percent when the buyer acquires the property for use as a residence and the amount realized is $1,000,000 or less, and no withholding is required when a buyer occupied residence sells for $300,000 or less.
• A seller who furnishes an affidavit stating a United States taxpayer identification number and that the seller is not a foreign person removes the sale from withholding under 26 U.S.C. 1445(b)(2).
• Washington's own closing tax runs the other direction. RCW 82.45.080 makes the real estate excise tax the obligation of the seller.

What It Means

FIRPTA, the Foreign Investment in Real Property Tax Act, is a collection device rather than a tax. The United States taxes a foreign person's Capital Gain on American real estate, but once the seller and the money have left the country there is nobody left to bill. So Congress put the job on the buyer. Under 26 U.S.C. 1445(a), the transferee is required to deduct and withhold a tax equal to 15 percent of the amount realized on the disposition of a United States real property interest by a foreign person, and send it to the IRS.

Two features catch people out. The withholding is measured on the amount realized, which is close to the gross price, not on the seller's profit. A foreign seller who breaks even on the sale still has money held back and has to file a United States return to get the excess refunded. And the trigger is a tax classification, not a passport. 26 U.S.C. 1445(f)(3) defines a foreign person as any person other than a United States person, so where the seller happens to be standing on closing day settles nothing. In practice the escrow officer runs the paperwork, but the legal duty sits with the buyer.

How It Works in Washington

In Washington the closing where a FIRPTA question surfaces is handled by a licensed escrow agent under chapter 18.44 RCW, the Escrow Agent Registration Act. RCW 18.44.011(7) defines escrow as a transaction in which a third person holds written instruments, money, or evidence of title until a specified event happens or a prescribed condition is performed, and then delivers it under the instructions given. That third person is where the FIRPTA file lands. The nonforeign affidavit, the withholding math, and the remittance all move through the Escrow office even though 26 U.S.C. 1445(a) puts the duty on the buyer.

Do not confuse the federal withholding with the state tax collected at the same table. The Real Estate Excise Tax Reet is imposed by RCW 82.45.060 upon each sale of real property, at graduated rates that run from 1.1 percent on the lowest tier of selling price up to 3 percent on the top tier, with the Department of Revenue adjusting the tier thresholds every fourth year. RCW 82.45.080 makes that tax the obligation of the seller, enforceable against the seller by an action of debt or in the manner prescribed for foreclosing a mortgage. FIRPTA comes out of the buyer's withholding duty and goes to the IRS. Excise tax comes out of the seller's proceeds and goes to the state. Both can appear on one Washington Closing Statement, and a broker who mixes them up will explain the wrong number to the wrong client. Our overview of Washington's evolving tax landscape is a useful companion for higher priced transactions.

Brokers are not bystanders here. 26 U.S.C. 1445(d) requires a transferor's agent or a transferee's agent who has actual knowledge that a nonforeign affidavit is false to notify the buyer, and an agent who fails to give that notice takes on the same duty to deduct and withhold that the buyer would have had. That exposure is capped at the amount of compensation the agent derives from the transaction, which for most listings is the commission.

Example

Kenji Watanabe, a Japanese citizen who is not a United States person for tax purposes, sells a Bellingham rental house for $820,000. The buyers, Sam and Rae Dolan, are moving into it themselves. Kenji cannot sign a nonforeign affidavit, so the exemption in 26 U.S.C. 1445(b)(2) is unavailable. The price is far above $300,000, so the small residence exemption in 26 U.S.C. 1445(b)(5) does not apply either. But the Dolans are acquiring the house for use as a residence and the amount realized is under $1,000,000, so 26 U.S.C. 1445(c)(4) substitutes 10 percent for 15 percent.

The escrow officer withholds $82,000 out of Kenji's proceeds and remits it to the IRS in the Dolans' name, because the Dolans are the transferees who owe the duty. At the same closing, Washington's real estate excise tax comes off Kenji's side of the settlement statement under RCW 82.45.080. Kenji later files a United States return for the year, reports his actual gain, and recovers whatever part of the $82,000 exceeded the tax he owed. Had the Dolans bought the same house as a rental instead of a home, neither residence rule would apply and the withholding would have been the full 15 percent, or $123,000. Our walkthrough of your first real estate closing shows where entries like these land on the statement.

Common Mistakes and Exam Traps

• The buyer is the withholding agent under 26 U.S.C. 1445(a). Washington's real estate excise tax runs the opposite way, and RCW 82.45.080 makes it the obligation of the seller.
• Withholding is calculated on the amount realized, close to the gross sale price, not on the seller's gain. A foreign seller who loses money on the sale is still subject to withholding.
• The $300,000 exemption requires the buyer to acquire the property for use as a residence. A $290,000 purchase held as a rental gets no exemption.
• Foreign person is a tax classification. 26 U.S.C. 1445(f)(3) defines it as any person other than a United States person, so the answer turns on federal tax status rather than on citizenship alone.