FIRPTA: Overview, definition, and example
What is FIRPTA?
FIRPTA (Foreign Investment in Real Property Tax Act) is a U.S. tax law that requires foreign sellers of U.S. real estate to pay taxes on the sale. To ensure compliance, buyers must withhold a portion of the purchase price and remit it to the IRS. FIRPTA applies to non-U.S. individuals and entities selling U.S. property interests, including land, buildings, and certain shares in real estate investment trusts (REITs).
For example, if a foreign investor sells a commercial property in New York, the buyer is required to withhold a percentage of the sale price and send it to the IRS as part of FIRPTA compliance.
Why is FIRPTA important?
FIRPTA is important because it ensures the IRS collects taxes on real estate gains made by foreign investors. Without this law, foreign sellers could avoid U.S. capital gains taxes by taking their profits out of the country.
For buyers, understanding FIRPTA is crucial to avoid penalties. If a buyer fails to withhold the required tax, they may be held responsible for the amount owed to the IRS. Real estate professionals, attorneys, and escrow agents also play a role in ensuring proper FIRPTA compliance during transactions.
Understanding FIRPTA through an example
Imagine a Canadian investor sells a residential property in Florida for $1 million. Under FIRPTA, the buyer must withhold 15% of the sale price ($150,000) and send it to the IRS. The seller can later file a tax return to determine if they owe additional tax or qualify for a refund.
In another example, a foreign corporation sells shares in a U.S.-based real estate investment trust (REIT). Since these shares are considered real property interests under FIRPTA, the buyer is required to withhold and remit the tax to the IRS.
An example of a FIRPTA clause
Here’s how a FIRPTA clause might appear in a contract:
“In accordance with the Foreign Investment in Real Property Tax Act (FIRPTA), the Seller certifies that they are not a foreign person under U.S. tax law. If the Seller is a foreign person, the Buyer agrees to withhold the applicable percentage of the purchase price and remit it to the Internal Revenue Service as required by law.”
Conclusion
FIRPTA is a U.S. tax law designed to collect taxes from foreign sellers of U.S. real estate. It places withholding obligations on buyers to ensure compliance. Understanding FIRPTA is essential for both foreign investors and buyers to avoid penalties and ensure smooth property transactions. Proper tax planning and legal guidance can help sellers manage FIRPTA withholding and potential refunds.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.