Disposition of Real Property by Foreigners

April 24, 2002

The disposition of a U.S. real property interest ("USRPI") by a foreign person (the transferor) is generally subject to income tax withholding under the Foreign Investment in Real Property Tax Act (“FIRPTA”) provisions of the Internal Revenue Code. Specifically, the transferee (i.e., the buyer) must deduct and withhold a tax equal to 10% of the total amount realized on the disposition (i.e., 10% of the purchase price). A disposition is defined as any transfer of USRPI by sale, exchange, gift, or any other transfer. This tax can often be a large amount, considering that the purchase price is usually much greater than the gain the transferor will recognize on the transaction. The obligation to withhold this tax rests with the transferee, who can be held liable for the tax if the proper withholding does not occur.

The Internal Revenue Service (“IRS”) does give the transferee three exceptions to the general withholding requirement on the exchange of USRPI to a foreign person. In the first exception, if the transferee acquires property for use as a personal residence and the amount realized (the sales price) is not more than $300,000, then the transferee will not be required to withhold the 10% tax. The transferee or a member of his or her family must have definite plans to reside at the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the date of the transfer. When counting the number of days the property is used, the days the property will be vacant should not be included. To establish a transferee's entitlement to rely upon this exception, no form or other document needs to be filed with the IRS. This first exception does not apply in any case where the transferee is other than an individual even if the property is acquired for or on behalf of an individual who will use the property as a residence. However, this exception applies regardless of the organizational structure of the transferor (i.e., regardless of whether the transferor is an individual, partnership, trust, corporation, etc.).

The second exception applies when the transferor gives the transferee written notice that no recognition of any gain or loss on the transfer is required because of a nonrecognition provision in the Internal Revenue Code or a provision in a U.S. tax treaty. The transferee must file a copy of the notice with the IRS by the 20th day after the date of transfer. Generally, in these cases, the transferor obtains a withholding certificate from the IRS indicating that no withholding is required.

The third exception upon which a transferee may rely is a withholding certificate from the IRS which excuses or reduces withholding to a rate other than the required 10%. The IRS may issue a withholding certificate that allows for a zero or a reduced withholding rate because of one of the following: 1) all of the gain realized by the transferor is exempt from U.S. taxation; 2) the amount required to be withheld would exceed the transferor's maximum tax liability; 3) the withholding of a reduced amount would not jeopardize collection of the tax; or 4) an agreement was entered into by the transferee or transferor for the payment of the tax by providing a security for the tax liability. The IRS has issued specific rules for obtaining a reduced withholding certificate regarding the timing of the application and the information required to be submitted; the specific rules are outlined in Revenue Procedure 2000-35. Unless one of the exceptions noted above applies, upon the transfer of a USRPI to a foreign person, the transferee is required to withhold 10% of the purchase price as tax.

For more information, please contact hnevin@cohenlaw.com or tcrombie@cohenlaw.com.