FIRPTA: What You Need to Know When Selling US Property as a Foreign Investor

When foreigners buy or inherit a property in the US, they don't automatically earn income from it. Consequently, they might not have a tax ID set up before they agree to sell the property. Therefore, Australians may be surprised when they first deal with the US tax system, as the selling solicitor might request an ITIN to finalize the pre-arranged sale.

The IRS has experienced too many foreigners who sell a US property for capital gains, but then never file a tax return to pay their capital gains tax. Therefore, in 1980, they implemented Foreign Investment in Real Property Tax Act - FIRPTA. This law forces the solicitor to withhold 15-30% of the sales price in escrow pending the issuance of an ITIN to the seller and that seller filing a tax return to settle their tax account with the IRS.

This situation can frequently delay the property's sale, as the law specifies that if the home seller doesn't have the required funds withheld, the buyer is legally responsible for paying any capital gains tax the seller might owe. Without the seller providing an ITIN, the withheld funds cannot be effectively held in escrow, potentially causing the sale to be postponed or fall through.

The sale of a home should not have to be stressful

Example: Australian citizens Jimmy and Cindy bought a Los Angeles house a few years ago for $1,000,000, and on January 15, 2023, they sell it for $1,200,000. Because Jimmy and Cindy are not US persons, the escrow company overseeing the sale must send $180,000 ($1,200,000 sales price x 15% withholding tax) into the IRS at close (January 15, 2023). But the actual tax they owe really is only around $30,000 ($1,200,000- $1,000,000 =$200,000 profit, x the general capital gains rate of 15%= $30,000 actual tax owed). So as of January 15, 2023, the IRS will hold $150,000 of real estate sale proceeds which really belong to sellers Jimmy and Cindy.

TIMING: The timing of the refund of the excess withholding tax possibilities are:

• The Typical Refund Timeline – The standard process for receiving a refund involves foreign sellers submitting a one-time US tax return for the calendar year following the sale. However, non-US sellers must follow several specific steps to qualify for a refund from the IRS (obtaining refunds from the IRS is not as straightforward as it may seem). If the Jimmy and Cindy adhere to these steps, they can expect to receive their refund around the middle of the subsequent calendar year after the sale (July 2025 based on the example provided). Although waiting for their refund may appear lengthy (18 months after the sale's conclusion), Jimmy and Cindy should consider themselves fortunate to receive any refund at all.

  
  

• Truncated Timeline - Foreign sellers have the option to request an early refund of excess withholding tax by submitting an IRS Form 8288-B Application. This form demonstrates to the IRS that the seller's profit was only $200,000, resulting in a tax owed to the IRS of $30,000, entitling them to a refund of $150,000. Proper completion of the form, which involves multiple steps for non-US sellers. Upon issuance of a withholding certificate by the IRS approximately four months after the sale (around May 2024 in this scenario), Jimmy and Cindy can obtain their $150,000 refund much earlier than the standard refund timeline.
  

GET AN ITIN BEFORE THE SALE: The goal is to obtain a US ITIN for the owner(s) before the sale.

• If you have received US income, then you can apply for an ITIN with your initial tax return. (Reason b). The IRS will assign your an ITIN and process your initial tax return together.

  
  

• If the sellers has not yet filed a US tax return, they can apply for an ITIN as members/partners of a US LLC (Exception 1a). Even if the LLC has an EIN, they will still need individual tax ID numbers. if the LLC is setup as a pass-through entity for tax purposes. Single member LLCs can apply for an ITIN with a support letter from their property manager (Exception 1d)

  
  

• If the sellers have never earned US income before this capital gains tax event, they must apply for an ITIN using Exception 4. After signing a sales contract, the seller needs to apply for an ITIN and submit a copy of the sale contract along with form 8288 (excluding the ITIN). This process takes a considerable amount of time due to mailing and processing delays, so it's crucial for all parties to be aware of the extended timeframe. Once the ITIN is issued, the seller provides it to the solicitor, who will then add it to form 8288 before sending it to the IRS with the FIRPTA proceeds. If form 8288 does not include the seller's full name(s) and ITIN, the IRS will reject any refund request when a tax return is filed.

GET AN ITIN AFTER THE SALE: This is called 'unscrambling the egg'. In this scenario, the closing closing attorney / solicitor has likely sent an incomplete 8288 to the IRS and placed the withheld tax in an IRS escrow account. To correct this, the solicitor must submit amended 8288 form(s) to the IRS which include the seller's Taxpayer Identification number (EIN/ITIN) and also a copy of the deposited check.

• STEP 1; The seller needs to obtain an ITIN to give it to the solicitor. The ITIN now must be obtained independently of the sale. There are a limited number of exception reasons where the IRS will issue an ITIN, so contact us to see if a pathway for obtaining an ITIN exists.

  
  

• STEP 2; Form 8288 must be re-completed by the selling solicitor, this time including the TINs of all parties on all parts of the form(s): 

  • Form 8288-A (copy A) is sent to the IRS with the withholding tax check.

  • Form 8288-A (copy B) is sent to the IRS, who will then stamp it and forward it to the seller. The seller must submit the stamped 8288-A form with their US tax return.

  • Form 8288-A (copy C) is retained by the withholding agent for their records.

Only once the seller has the IRS stamped 8288-A (copy B), should they submit a US tax return. The IRS needs to stamped 8288-A in order to match the funds held in escrow with any refund request.

Careful- Many Non-US Sellers Will Never Receive A Refund – Because of the rigidity and complexity of the process, numerous foreign sellers find it difficult to receive their refund. Failure to follow the process will result in the IRS retaining the excess withholding tax. The exact percentage of non-US sellers who do not receive their withholding tax refund is uncertain, but it is estimated to be a substantial portion of all foreign sellers who never receive a refund.

Therefore, foreign investors should plan ahead before selling their US property. Obtaining an ITIN prior to listing a property for sale is strongly advised. It is much simpler than applying during or after the sales process. For more information visit: https://www.irs.gov/pub/irs-pdf/f8288.pdf