FIRPTA: Don't Make This Mistake When Buying a Home

Have you ever heard of FIRPTA? If not, then it is something you might want to pay attention to when you are looking to purchase your next home. FIRPTA stands for Foreign Investment in Real Property Tax Act of 1980. Well that really clears up a lot, doesn't it? FIRPTA is a federal law that pertains to foreign owners of real estate. So you are probably thinking to yourself how that has nothing to do with you, right? You are not a foreigner are you? Well, our government in their brilliance has made this a concern for everyone, not just foreigners. You are probably asking yourself "why" right about now. Read below to find out. 


What is FIRPTA?

The Foreign Investment in Real Property Tax Act, or FIRPTA, was created in 1980 in order to ensure that capital gains taxes were paid by foreign entitities whenever they sold real estate. The idea behind it is that if someone from say Europe were to invest in real estate in the US and then sell the property they could wire the funds out of the country before the IRS was able to tax those funds. This person being a foreigner would limit the IRS's ability to then collect the tax. On the other hand, a US person would be forcred to pay the taxes through their regular return, so there isn't as much of non payment. 

Prior to the passing of this act most foreigners were not subject to any tax on real estate. When the act was originally passed it required a witholdin of 10%, but in 2016 this was increased to 15%. Now, you are probably still wondering what that has to do with you, the buyer. Well since the IRS doesn't have an enforcement mechanism to ensure foreign persons pay the tax, they require the buyer to withold the tax from the purchase price. Similar to how employers withhold taxes from their employees paychecks, the buyer is supposed to send that 15% to the IRS instead of paying it to the seller. For instance, say you buy a $300,000 house from a foreign person. The buyer is then required to keep 15% or $45,000 from the purchase price and instead give it to the Treasury Department. The foreign person can then file a tax return and request a refund on any overpayment. Again, just like with employee and employers. 

What Does Foreign Person Mean?

So, how do you know if someone is a foreign person? Well, they are supposed to disclose that to perspective buyers. What even is a foreign person as it pertains to FIRPTA? Well, first off, US Citizens are not foreign person, and neither are legal residents. If they have a greencard, FIRPTA doesn't apply becuase they file a tax return. Domestic Companies are also not foreign entities.  There is also an exception to foreigners that meet the "substanial presence test". This is a complicated formula that the IRS uses to determine if someone lives in the United States enough to qualify for this exemption. There is another exemption using another complicated forumla called "first year election". Ultimately the best option is for the seller to speak to a CPA for guidance if they think they might fall under FIRPTA.  

How to Avoid Problems

Now where does that leave you as a buyer? Well keep an eye out for any sellers you think might be a foreign person. Ask questions. If you do end up purchasing a home from a foreign person it is probalby best if you consult with a CPA and have them assist you in the filing and witholding . But ultimately it is important that the buyer agent you work with understands FIRPTA and keeps an eye out on your behalf. You don't want to pay the seller the full price and then have the IRS come back on you asking for the unpaid taxes. A good agent will also try to negotiate for the foreign seller to pay any CPA and filing costs associated with the purchase. Because it isn't your fault the seller is a foreign person. 

Hopefully you now have a better understanding of FIRPTA and know what pitfalls to lookout for. Please contact us if you have any questions. As always, if you are looking to buy or sell a home please reach out to us. We will gladly assist you. 

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