FIRPTA Withholding Risk When Assigning Real Estate Contracts

Foreign individuals or entities that purchase U.S. real estate are often unsure at the time of signing the offer to purchase as to how they wish to take title. Such individuals or entities often maintain flexibility by retaining the right to assign the contract to another person or entity at closing.

Example

Assume Michael a nonresident alien (a foreign person) signs a contract to purchase a U.S. residence for $350,000 from a U.S. citizen. The purchase contract lists the buyer as “Michael or assigns”. Michael formally agrees with his foreign spouse (or his foreign corporation) to assign the contract to his spouse (or his foreign corporation) and his spouse or his corporation takes title to the residence.

FIRPTA withholding tax would not have applied if Michael had purchased the property. However the closing agent (and buyer) are apparently required to collect FIRPTA withholding tax at the time Michael’s spouse (or Michael’s corporation) take title to the real estate unless an exception applies.¹

FIRPTA Withholding Required by the Closing Agent

When a foreign person (i.e. a foreign individual corporation trust or estate) disposes of U.S. real estate the U.S. tax code imposes a withholding tax (“FIRPTA withholding tax”) at the time of sale which must be collected and remitted by the closing agent (or buyer) unless an exception applies.²

In addition to actual sale (disposition) of real estate the FIRPTA withholding tax applies when there is a disposition (assignment) of a real estate contract.³ Thus in the above example Michael (a foreign person) is treated as if he disposed of U.S. real estate when his spouse or his corporation exercises the assignment and takes title to the real estate.

The withholding is based on the “amount realized”,⁴ which is normally the selling price. Of course there is usually no “selling price” per se when Michael assigns the contract to his spouse or to his corporation. However the tax code defines the “amount realized” to include the “…. amount of liability assumed by the transferee…”.⁵

Since the full purchase price was a liability assumed by the assignee (Michael’s spouse or Michael’s corporation) one can argue that the amount realized includes an amount up to the full purchase price on the contract. The FIRPTA withholding can be waived if an IRS withholding certificate is obtained.

U.S. Tax Return Required by Michael

Since Michael is treated in the above example as having disposed of U.S. real estate he must file a U.S. income tax return to report the “sale”. If he received nothing else in the assignment there would be no profit and no tax due on the tax return. One additional benefit of complying with the tax return filing requirement is to retroactively eliminate the penalty for failure to comply with the FIRPTA withholding requirement.

Assistance From Realtors

Realtors may be able to assist in avoiding all of the above by:

1. Arranging a cancelation of the original purchase contract and its replacement with a contract in the name of Michael’s spouse or Michael’s corporation as the case may be or
2. Arranging for the U.S. citizen seller to release Michael from his obligation to purchase the property or
3. Encouraging Michael to apply for an IRS withholding certificate to eliminate the FIRPTA withholding requirement and related penalty for the closing agent (and for Michael’s spouse or Michael’s corporation).

Another Potential Concern About Assignments to Individuals

Unlike gifts to U.S. citizen spouses U.S. gift tax may apply when a nonresident alien gives U.S. real estate to his/her nonresident alien spouse or other individual if the value of the gifted real estate exceeds the annual inflation-adjusted gift tax exemption for that type of gift. For 2023 the exemption is US $175,000 for gifts to a nonresident alien spouse,⁶ and US $17,000 for gifts to each child or other individual.

In the example with Michael above a U.S. taxable gift may occur from Michael to Michael’s spouse if Michael sends the $350,000 purchase price amount to the closing agent and the property is purchased in the name of Michael’s spouse without Michael being reimbursed.

^[1] For example, an exception would apply if an IRS withholding certificate is obtained, exempting the assignment on the basis there is no profit on the assignment from Michael to his spouse or to his corporation

^[2] Withholding is imposed under IRC §1445 to aid enforcement of the Foreign Investment in Real Property Tax Act (FIRPTA) under which the actual income tax is levied on any profit, generally under IRC §897

^[3] See Treasury Reg. §1.897-1(d)(2)(ii)(B)

^[4] IRC §1445(a)

^[5] Treasury Reg. §1.1445-1(g)(5)(iii)

^[6] IRC §2523(i)