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Foreign Investment In Real Property Tax Act
Tax Information for Foreign Owners of U.S. Real Estate
Foreign Persons Involved in U.S. Real Estate Transactions:
With the increasing globalization of trade and investments, foreign ownership of U.S. real estate continues to steadily grow. Consequently, U.S. real estate professionals and rental agents/property managers are encountering an increasing number of situations that involve foreign persons acquiring U.S. real estate as a part-time residence, for investment or in some cases to conduct a U.S. business. The U.S. tax rules that apply ownership and dispositions of U.S. real estate by foreign persons are different in some important respects from the rules that apply to U.S. persons.
This article discusses the U.S. federal income tax rules that U.S. real estate professionals must know to properly deal with foreign investors in U.S. real estate, and to avoid certain personal liabilities for improper U.S. federal income tax compliance. The first part of this article covers the rules that determine whether an individual or entity is to be treated as U.S. or foreign. The second part discusses compliance with the Foreign Investment In Real Property Tax Act (FIRPTA) for sales by foreign persons of U.S. real property interests (USRPI). The third part provides the fundamentals of U.S. federal income taxation of foreign investors with U.S. rental income.
The Foreign Investment in Real Property Tax Act:
Section 897 of the Code (enacted under the 1980 FIRPTA legislation) provides rules for the taxation of nonresident alien individuals and foreign corporations on sales or other dispositions of U.S. real property interests (including installment sales, exchanges, foreclosures, and deeds in lieu of foreclosure of a U.S. real property interest.)
FIRPTA applies to what it defines as a U.S. real property interest, which includes not only interests in land, but interests in buildings, mines, wells, crops and timber as well. Because Congress was concerned that foreign persons would try to avoid FIRPTA by incorporating their U.S. real estate holdings, a U.S. real property interest is defined to also include any interest in a U.S. corporation if that U.S. corporation is a "U.S. real property holding company," with the result that a disposition of its stock by a foreign investor may be subject to federal income tax under FIRPTA. A U.S. corporation is a U.S. real property holding company if the fair market value of its U.S. real property interests equals 50% or more of the sum of the fair market value of its U.S. real property interests, interests in real property located outside of the United States, and trade or business assets. A foreign corporation may also be classified as a U.S. real property holding company, but the sale of stock in a foreign corporation by a foreign person generally is not subject to U.S. federal income tax (although other important U.S. federal income tax consequences may result).
Since 1985, a disposition of a U.S. real property interest by a foreign corporation or nonresident alien individual generally is subject to a withholding tax regime under section 1445 of the Code. Under the withholding tax regime, any purchaser of a U.S. real property interest from a foreign seller must withhold fifteen percent (15%) of the gross purchase price and remit such amount to the IRS within 20 days of the closing. The purchase price includes cash plus the fair market value of any other property transferred to acquire the real estate. A purchaser failing to withhold is liable for any uncollected withholding tax, as well as penalties and interest charges.