FIRPTA – Buyer Beware

Posted on by Phil Querin

Lately, there have been some stories about Realtors® and/or title companies having to pay a foreign seller’s federal income tax that was not withheld at the time of closing as it should have been.  About a year ago there was a significant change to how title companies handle FIRPTA withholdings that received scant attention in the Realtor® industry.

FIRPTA is the federal law that assesses a 10% tax on the amount realized by a foreign person upon closing of their sale of real property in the United States and Virgin Islands.    A “foreign person” subject to FIRPTA generally includes non-resident aliens and foreign corporations.  It does not include “resident aliens.”  The “amount realized” is the gross sales price not reduced by the costs of sale or recorded liens. [Note: The tax is not on gain or “profit”  – but gross proceeds of sale.  This suggests that FIRPTA could apply even to short sales, if they are over $300,000 and the seller is a “foreign person.”  If it appears your transaction may involve a non-resident alien, sellers should be advised to seek competent tax counsel – and buyers may wish to do so as well.  This is not an issue the seller or buyer should be addressing for the first time at closing. – PCQ]

There are several exceptions to the FIRPTA law, the primary of which include the following: (a) Sale price of the residence is $300,000 or less; (b) Seller is not a “foreign person;” (c) The property is not a U.S. real property interest; (d) The seller properly certifies that he/she is not required under IRS rules to recognize gain or loss.

However, the FIRPTA law takes a peculiar approach to sales in which the 10% withholding does not occur at the time of closing – it holds the buyer liable for the amount that should have been withheld.  This can potentially include other professionals involved in the transaction such as the title company and the buyer’s real estate agent.  At 10% of the gross sale proceeds, this is not an insignificant liability, and when appropriate, Realtors® should encourage their seller clients to secure competent legal/tax advice on the issue. Conversely, in those cases where the seller claims an exemption from FIRPTA, buyers may wish to consult their own counsel about their own liability should the claim of exemption be potentially false.  Realtors® should avoid “advising” clients on the applicability or non-applicability of FIRPTA to their transaction.

For many years, FIRPTA was not something most Realtors® had to concern themselves with.  This is because most closings routinely included a document known as Non-Foreign Certification that was given to sellers to sign.  If the seller was a non-resident alien, escrow collected the tax withholding and turned the funds over to the IRS within 20 days, as required by law.  However, a federal housing bill adopted in June 2008 enabled sellers and buyers to appoint a “Qualified Substitute” to collect the funds and retain records related to the Non-Foreign Certification.  A “Qualified Substitute” is defined as (a) the seller’s agent or (b) a person (including an attorney or title company) responsible for closing the transaction, other than the seller’s agent.  FIRPTA created monetary liability against the Qualified Agent for non-compliance with its rules.  As a result, most title companies have declined to act as a Qualified Substitute.  Now, escrow includes a document in closing that releases them from responsibility to act as a Qualified Substitute to collect the funds or retain the records.  The result is that today there is a potential gap in the closing process where there may be no withholding, even though the seller is a “foreign person” under FIRPTA.  This could result in liability to buyers, and ultimately to their Realtors® and others.

What makes this change in protocol somewhat surprising is that for several years, the OREF Sale Agreement has contained the following clause, which seems to be a pretty clear instruction from the principals:  “If Seller is a foreign person as defined by FIRPTA, or a non-resident individual or corporation as defined under Oregon law, Buyer and Seller instruct Escrow to take all necessary steps to comply therewith.“ It appears the position of the title companies is that they are relieved from compliance with this instruction because of the document signed by the parties in closing, excusing them from acting as a Qualified Substitute.

However, it is important to add that if specifically requested to do so before closing, title companies will generally honor the parties’ request to submit withholding forms and funds to the IRS when FIRPTA applies.  The request should be made in such a manner as to clarify that it is intended to override any closing documents escrow might include indicating otherwise.  It should also be done well before escrow has commenced drafting the closing documents. [For those interested, see IRS Form 8288 (Rev. 11-2009), which contains several pages of FIRPTA information.  Of particular interest is the “Liability of Agents” section at pages 4-5. – PCQ]

Clearly, the root of the problem is timing.  Practically speaking, the issue of non-resident alien status should be vetted early in the transaction – perhaps even at the listing stage.  One suggestion made by some experts is that it be addressed in the listing agreement itself.  Whether it is on the public or private side needs to be determined.  But, in any event, this approach is seen as a good “work-around” that permits the title industry and the Realtor® industry to both control their risk.

In the meantime, the issue of non-resident alien status should be an issue for principal brokers to keep in mind, and perhaps even develop company policy, if not already in place.  While such transactions are not numerous, one mistake can result in significant tax liability for the Realtors® involved.

Posted in Legislation - Federal, Miscellany, Real Estate General, Real Estate/Distressed, Realtors, Tax Issues | Tagged , ,
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