The Foreign Investment in Real Property Tax Act (“FIRPTA”)

FIRPTA for non-US Persons

If you’re a foreign person looking to sell a property in the United States, you should be aware of the Foreign Investment in Real Property Tax Act (FIRPTA). This law authorizes the IRS to tax foreign persons on the sale or disposition U.S. real property interest (USRPI). Essentially, FIRPTA requires the purchaser of a USRPI to withhold tax on the payment for the property, although this requirement may be reduced under certain circumstances.

Before FIRPTA was enacted, foreign persons were not typically subject to U.S. tax on the sale of U.S. real estate. The purpose of FIRPTA was to level the playing field between foreign and U.S. investors in U.S. real property by requiring non-U.S. persons to pay tax on the disposition of U.S. real estate.

Generally, U.S. persons are taxed on their income from all sources (foreign and domestic), while non-U.S. persons are only taxed on a limited category of U.S.-source income, such as income that is effectively connected with the conduct of a U.S. trade or business (Effectively Connected Income, or ECI). Capital gains are typically sourced to the residence of the seller, so under the general rule, a non-U.S. person’s sale of property would result in foreign-sourced income.

However, FIRPTA changes this rule for foreign persons disposing of a USRPI. Section 897 of the Internal Revenue Code treats gains and losses from a foreign person’s disposition of a USRPI as effectively connected with the conduct of a U.S. trade or business, thus converting the income into a category that is subject to taxation.

So, what is a USRPI? The term is defined broadly in Section 897 to include an interest in real property located in the United States or the Virgin Islands, as well as an interest (other than an interest solely as a creditor) in a domestic corporation that is a U.S. real property holding corporation (USRPHC). A USRPHC is a corporation on a particular date if the fair market value of its USRPIs equals or exceeds 50% of the sum of the fair market value of its USRPIs, interests in real property located outside the United States (foreign real property interests or FRPIs), and other assets used or held for use in a trade or business.

A USRPI specifically includes land and natural products, improvements to real property, personal property associated with the use of the real property, timber, growing crops, mines, wells, buildings, oil and gas pipelines, leaseholds, options, contracts, and rights of first refusal to acquire an interest in real property (other than an interest solely as a creditor).

Disposition of a USRPI includes any sale, exchange, liquidation, redemption, gift, or other transfer for any purpose under the Internal Revenue Code. If you’re a transferee purchasing a USRPI from a foreign person, a purchaser’s agent, or a settlement officer, you’re required to withhold tax on the payment for the property. However, the amount of tax withheld may be reduced if the foreign person obtains a withholding certificate from the IRS or if an exception or exclusion applies.

It’s important to note that FIRPTA applies to both foreign individuals and foreign corporations. If you’re a foreign corporation disposing of a USRPI, you may be subject to additional tax under the branch profits tax. This tax is designed to ensure that foreign corporations are taxed on the same basis as domestic corporations, and it applies to the net investment income of the corporation