February 8, 2017
Realtors with Foreign Clients: US FIRPTA Withholding Tax Guidance (Part 1), "Residence" Use Exception
Florida Realtors are aware that federal withholding tax of 15% of the selling price generally applies to the sale of US real estate by a foreign individual, or by a foreign entity. Referred to as “FIRPTA” withholding, it was imposed in 1985 to enforce compliance with the “Foreign Investment in Real Property Act” which was enacted in 1980.
There are several exemptions and reductions related to FIRPTA withholding. One confusing set of those exemptions is based on whether the buyer will use the purchased property as a “residence”.
RESIDENCE EXEMPTION FOR SALES NOT EXCEEDING $300,000
When the selling price does not exceed $300,000, the regulations state there is no withholding if, on the date of the transfer, the buyer (or buyers) has definite plans to reside at the property for at least 50 percent of the number of days that the property is used by any person during each of the first two 12-month periods following the date of the transfer. In practice, that rule is often misinterpreted.
The residence is not required to be buyer’s principal residence, and the buyer is not required to be a US citizen or US resident. But the buyer must be an individual, (e.g. it cannot be a corporation whose shareholder intends to use the property as a residence), and the purchase must be a residence, not land on which a residence will be constructed.
Simplistically, if the buyer, at the time of sale, has plans to reside at the property, more than it will be rented out, over each of the following two 12-month periods, the sale is potentially eligible for the exemption.
Uncertainty can arise in counting days of residing at the property. There is good news. First of all, days in which the buyer’s “family” will reside at the property can be counted as days the buyer will reside at the property. Second, the days the property is planned to be vacant can be ignored in the 50% threshold computation.
Example 1: Stephen and Rachel, husband and wife, are buying a Florida condo for $300,000. They plan to use (reside at) the condo all of December, April and May each year, and plan to rent it out January, February and March each year. Their 2 adult children plan to each use the condo for ½ of July each year. It will be unused the remainder of the year. In this case, the sale is potentially eligible for the exemption because the family plans to use (reside at) the property more than 50% of the time it will be used by any persons. (The usage by the family is 57% of the total time – i.e. 4 months of 7 months - because vacant time is ignored).
RESIDENCE RULE FOR SALES EXCEEDING $300,000, BUT NOT EXCEEDING $1,000,000
The 15% withholding rate is potentially reduced to 10% if the selling price exceeds $300,000, but does not exceed $1,000,000, and the buyer meets the same “Residence” and “50% rule” described above. Thus, if the facts are the same as in Example 1, except that the purchase price is $450,000, the 15% withholding rate is potentially reduced to 10%.
Example 2: Michael and Danielle, husband and wife, are buying a Florida condo for $850,000. They plan to make it available free for friends with young children in the summer months of June through August each year, so the children can go to the beach. They plan to use it themselves from January 1 to April 15 each year, and perhaps a few weeks at other times during the year (except of course during June, July and August). Otherwise the property will be vacant. The sale is potentially eligible for a reduction in the FIRPTA withholding from 15% to 10% because the buyers and family plan to use the property more than 50% of the time it will be used by any persons. (The usage by the family is 58% of the total time – i.e. 3½ months of 6 months - because vacant time is ignored).
It is the buyer, not the seller, who has the liability with the IRS if the withholding tax is not remitted timely and properly. Thus, if the exemption or reduction is being claimed, the closing agent will normally require an affidavit from the buyer confirming the buyer’s intended use.
Suppose the buyer signs the affidavit, but later, during the 2 year period, genuinely changes his/her mind, and rents the property 50% or more of the time it is used by all persons. (i.e. the buyer does not comply with his/her original affidavit). Then, no penalty will be levied on the buyer, if the buyer establishes that his/her failure to reside the minimum number of days was caused by a change in circumstances that could not reasonably have been anticipated at the time of the transfer.
US FIRPTA Withholding Tax Guidance (Part 2) will be sent to you in the future explaining other exemptions to FIRPTA withholding, and also providing separate tax saving ideas for your foreign clients.
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