FIRPTA Withholding

by | Feb 13, 2018 | Cracking the Tax Code with Christy | 0 comments

Are you buying or selling real property in Hawaii?  If so, are you familiar with the tax rules known as FIRPTA? That’s the Foreign Investment in Real Property Tax Act of 1980. It was designed to guarantee that federal income tax liability arising from the gains of real property sales is paid if the seller is a foreign entity.

Buying or selling real property can become a major concern in states such as Hawaii, where a significant amount of land is transferred by foreign entities. While there could be a few exceptions, under FIRPTA 15% of the purchase price must be withheld at the time of the sale and paid over to the IRS within 20 days of closing the sale.  That withholding becomes security for the IRS in case the seller fails to pay income tax due from the sale or any other income taxes potentially owed.

Because of FIRPTA, both buyers and sellers in Hawaii face potential difficulties before and during real estate transactions.  It’s the buyer who bears responsibility for making certain the withholding occurs.  Buyers can be assessed the tax themselves if they fail to act with due diligence concerning their tax obligations. And sellers face other financial complications, including filing specific requests to the IRS long before closing dates or having to wait for extended periods to recoup the withholdings, even if they owe no tax and are due refunds.

If you’re thinking about buying or selling real estate in Hawaii, it’s to your advantage to acquaint yourself with the basics:

  • FIRPTA typically applies if the seller does not declare under penalty of perjury that the seller is not a non-resident alien for purposes of U.S. income taxation. The IRS’s standard definition of “non-resident alien” includes individuals who aren’t U.S. citizens and U.S. branches of foreign corporations, partnerships, trusts, and estates.
  • If the non-resident alien doesn’t have a taxpayer identification number (“TIN”), he or she must obtain one prior to selling real property. Buyers should ask for evidence of the TIN before making offers. Both the buyer and seller should exchange TINs immediately at the time of an offer.
  • Buyers must ensure that the withholding occurs at the closing date. Buyers can’t assign the responsibility for withholding to any other party, including escrow agents.  If a buyer fails to ensure that the withholding occurs, the IRS can assess the buyer the tax.
  • It doesn’t matter whether the non-resident alien makes a profit or not at the time of the sale – the 15% withholding applies unless the seller can prove that the IRS has granted an exemption to FIRPTA.
  • One possible exemption involves property selling for under $300,000. If the buyer intends to live in it, the buyer can sometimes avoid the FIRPTA requirements by signing a sworn affidavit stating those facts.
  • Up until the date of closing, a seller can ask for an exemption of the withholding by filing IRS Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests. However, the application process takes time and can slow down a successful sale.  If the IRS doesn’t issue the Certificate by the closing date, the 15% withholding is retained in the title company or closing agent until the seller produces the Certificate.
  • When there is withholding, in order to recoup the funds, the seller must apply for a refund by filing the appropriate federal income tax return at the end of the seller’s fiscal year. This process can take up to 18 months. The seller must also be compliant with filing all required U.S. tax returns for years when rental income was received from the property.

Because of the potentially serious complications of selling or purchasing real property in Hawaii, consulting with a tax professional is recommended.  When you’re ready to transfer real estate, give Law Offices of Christy Lee, P.C. a call. We’ll protect your best interests while ensuring your observance to the law.