On December 18, 2015, the Protecting Americans from Tax Hikes Act (PATH) was signed into law, amending, among other things, the Foreign Investment in Real Property Tax Act (FIRPTA). The most significant change is that there has been an increase in the withholding rate from 10% to 15%. What this means is that the buyer’s attorney will withhold 15% from the purchase price to a foreign seller and submit this amount directly to the IRS. The foreign seller will now walk away with 15% less (rather than 10%) from sales of U.S. real property interests but may be entitled to a refund, at least in part, if its income tax is less than the 15% that was withheld from the purchase price.
The increase to 15% also applies to distributions by certain domestic corporations to foreign shareholders and distributions by domestic or foreign partnerships, trusts, or estates. However, the 10% withholding rate still applies to personal residences that have a purchase price of less than $1 million.
The increased withholding tax rate ensures tax compliance by a foreign person or entity by offsetting any tax owed on a sale of real property. Planning ahead can allow a foreign seller to either reduce the time that the withheld funds are held in escrow, or eliminate the requirement to withhold any sale proceeds.
The seller’s attorney can make an application to the IRS for a Withholding Certificate, requesting a reduction in the percentage withheld from the sale, based upon a showing that the seller’s maximum tax liability is below 15% of the purchase price. If this Withholding Certificate is approved, the buyer’s attorney, instead of the IRS, holds the funds in escrow; which can greatly expedite the seller’s access to the funds. Alternatively, a foreign seller may be exempt from withholding all together. This determination depends upon a list of reasons; a common reason is if the property is a personal residence and the purchase price is $300,000 or less.
The increased withholding tax rate is effective for dispositions occurring on or about February 16, 2016, which is 60 days after PATH was signed into law.