FIRPTA and Buyer Liability. Until the last few years, the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) was just an arcane acronym; most residential real estate brokers had no knowledge of what it stood for, what it was, or how it worked. Fewer cared. After all, they had never handled a FIRPTA transaction involving the sale of real property by “foreign persons”.[1]
But during the Great Recession, it was widely believed that as prices plummeted, many foreign persons were purchasing homes in the United States for investment. It was also widely assumed that eventually these buyers would become sellers, so the real estate industry needed to familiarize itself with FIRPTA, since it levies a 15% tax on gross proceeds at closing.
Eventually, alarm bells began to go off when it became known that if the law applied to a transaction, but was ignored, the buyer becomes automatically liable for seller’s tax bill. Suddenly, real estate agents and their brokerages began to become concerned about their duty to appropriately inform their buyer-clients about the application of FIRPTA if the seller was a foreign person.[2] And how would they know which seller was a foreign person and which one was not?
As many brokers know, the RMLS™ listing form asks sellers whether they are a foreign person. And until the 2019 OREF Sale Agreement form was published, it contained a representation that the seller was not a foreign person.[3] So, the question naturally arises, “If FIRPTA applies, and the seller is a foreign person, but says they are not, are the representations in the RMLS™ listing and Sale Agreement sufficient to insulate the buyer from liability for the seller’s taxes?” Unfortunately, the answer is “No”.
Seller Certification (or Affidavit) of Non-Foreign Status. But the buyer is absolutely protected – like crosses to vampires – if the seller signs a Certification of Non-Foreign Status (“Certificate”). It is a fairly benign document: (a) stating that the seller is not a nonresident alien for purposes of U.S. income taxation; (b) identifying their Social Security Number (or Employer Identification Number); and (c) their home address.
Above the seller’s signature is an acknowledgment that it may be disclosed to the IRS by the buyer, and that if any of the above statements are false, it could be punishable by fine, imprisonment, or both. Then, “under penalties of perjury” the seller signs declaring that they have examined the document and to the best of their knowledge and belief it is true, correct, and complete.
The Rub. Hmmm. Sounds simple enough. Nada. You see, under the FIRPTA law, the Certificate is to be given to the buyer to hold for five years. How many sellers do you suppose would willingly turn over their Social Security Number to their buyers to hold for half a decade?
Enter the Qualified Substitute Rule. The answer is obvious – find someone else to do so. In 2008, the “Qualified Substitute” law went into effect, which “…means, with respect to a disposition of a United States real property interest— (A) the person (including any attorney or title company) responsible for closing the transaction, other than the transferor’s agent, and (B) the transferee’s agent.”[4] So in Oregon, the buyer’s real estate agent or the title company closing the transaction may serve as the Qualified Substitute for the buyer to hold the Certificate. In that capacity they must deliver to the buyer a signed declaration under penalty of perjury that they are in possession of the Certificate.
The Other Rub. How many sellers do you suppose would willingly turn over their social security number to their buyer’s real estate agent/brokerage to hold for half a decade?
Role of Oregon Title Insurance Companies as Qualified Substitutes. Though it was not always the case, as of 2019, all major title companies in the Portland Metro area have agreed to serve as Qualified Substitutes. I believe this is also the case in the Bend area of Central Oregon.
This is an accommodation that only makes sense – who is in a better position to electronically retain the Certificate with the seller’s social security number or Tax ID Number than the title company that handled the transaction from the opening to closing of escrow, disbursement of funds, and recorded the deed of conveyance? And we know that sellers do not object to providing escrow with their social security number or Tax ID Number – it is required in order that escrow can complete and submit the 1099-S (Proceeds from Real Estate Transactions) to the IRS.
In short, Oregon title companies are the obvious entities to serve as Qualified Substitutes. And if truth be told, many – if not all of them – have been having sellers sign a Certificate for every transaction they close, regardless of whether they are “foreign persons”. What they haven’t been doing, at least until now, is “formally” acting as the Qualified Substitute, and providing every buyer with a declaration they received the seller’s Certificate and will hold it for the required five-year period of time. This is no burden, since under Oregon Real Estate Agency regulations, title and escrow companies are required to hold their transactional records for not less than six years.
Why is This Important for Oregon Realtors? When buyers or sellers are damaged, or believe they have been damaged, or are threatened with damage, the first place they look is to their real estate broker. If a seller lied about being a “foreign person” subject to FIRPTA and the buyer got tagged for the seller’s tax liability, it is likely they would ask their own broker why they weren’t warned about this. And that broker could likely ask the seller’s broker why it wasn’t vetted at the time of taking the listing.
And what will escrow say when asked why they didn’t vet the issue? They will respond that they act as a “neutral” and do not render advice, and have no duty to vet the FIRPTA issue with sellers and buyers. And lest you doubt this, sit down in a quiet room free of distractions for an hour, and closely examine the carefully drafted escrow instructions that both parties sign, and the title insurance disclaimers on their policies.
The Solution Going Forward. Oregon Realtors have no business doing something escrow should be doing when a real estate transaction is first opened: Have the seller and buyer instruct escrow to immediately get the Certificate of Non-Foreign Status signed by the seller, and then provide a declaration to the buyer at closing that it is holding that document and will do so for the required period of time. How difficult is that? Realtors should not want their fingerprints on the Certificate. Let escrow do the job they are used to doing.
Remember, escrow has no duty to proactively vet the “foreign person” issue. That is why it is important for the brokers to make that a priority in every transction – when escrow is opened, have seller and buyer “instruct” it to (a) get a Certificate of Non-Foreign Status signed by the seller, and (b) deliver a declaration to the buyer at closing that they are holding it. If necessary, put this instruction in writing, get seller and buyer to sign, and submit it to escrow.
And an added benefit of this is that 75% of the current FIRPTA section can be eliminated from the OREF Sale Agreement, since Realtors will no longer need to vet the issue in order to protect themselves from liability. With luck, all of the current inventory of FIRPTA forms can be eliminated, since FIRPTA will no longer be the elephant in the (closing) room.
Does This Result in any Added Burden to the Title/Escrow Industry? No, they’ve been quietly getting Certificates signed for years; they already hold them for six years – one year longer than the IRS requires; they already have their seller’s Social Security or Tax ID Number; and since they already collect and disburse funds, if they have to remit the seller’s FIRPTA withholding taxes, it is simply another part of their existing closing protocols[5] – similar to that required for Oregon withholdings for out-of-state sellers.[6]
As for title and escrow companies in small towns, there are anecdotal reports that some of them may be hesitant to act as a Qualified Substitute since they are unfamiliar with the law. However, we know that their title insurance is underwritten by the larger companies. So, the solution seems to be for the larger companies to educate their smaller brethren about this law. It isn’t complicated: It only requires having sellers sign a Qualified Substitute form and delivering a declaration to their buyers confirming they are holding it. ~Phil
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[1] According to the IRS here, “A payee is subject to nonresident alien (NRA) withholding only if it is a foreign person. A foreign person includes a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, a foreign estate, and any other person that is not a U.S. person. It also includes a foreign branch of a U.S. financial institution if the foreign branch is a qualified intermediary. Generally, the U.S. branch of a foreign corporation or partnership is treated as a foreign person.”
[2] This is not to suggest that FIRPTA makes brokers automatically liable if the withholding law is ignored. But if a buyer ended up having to pay their seller’s FIRPTA withholding, that buyer could quite possibly ask: “Why didn’t my agent inform me about this risk?”
[3] Why it was removed is a mystery to me. It should be put back, along with an affirmative representation that the seller will cooperate with escrow in signing whatever documents and forms escrow requires for closing with a non-foreign person.
[4] See, https://www.law.cornell.edu/uscode/text/26/1445
[5] To be clear, title companies have never objected to withholding a seller’s FIRPTA taxes and remitting them to the IRS. The only objection by many of them – until now – has been formally serving as the Qualified Substitute.
[6] Escrow is required to withhold and disburse to the Oregon Department of Revenue taxable gains on real property sold by out-of-state residents. See, discussion here.
