FIRPTA and the Foreign Seller: 15 Percent Withheld Before the Exchange Starts

Foreign investors own a large amount of US real estate, and many would like to use 1031 exchanges just as US investors do. They can. The rules for deferring gain through an exchange apply to foreign persons as well.

The complication is a separate law: the Foreign Investment in Real Property Tax Act, known as FIRPTA. It requires buyers of US real property from foreign sellers to withhold a percentage of the sale price and send it to the IRS. Without planning, that withholding can take a large bite out of the exchange before it begins.

What is FIRPTA withholding?

When a foreign person sells US real property, the buyer is generally required to withhold 15 percent of the amount realised, usually the sale price, and remit it to the IRS. The withholding is a prepayment toward the seller's US tax, not the tax itself.

The buyer is responsible for withholding. If they fail to do so, they can be liable. That is why buyers and escrow agents take FIRPTA seriously and will not simply waive it on the seller's word.

Why is this a problem for an exchange?

Because the 15 percent withheld is not available to the Qualified Intermediary. On a 2 million dollar sale, 300,000 dollars would be sent to the IRS, leaving less to reinvest. Unless the seller replaces that amount with other funds, the replacement purchase shrinks and part of the gain may be taxed.

The withholding also applies to the sale price, not the gain, so it can be far larger than any tax actually owed when an exchange defers the gain entirely.

Can the withholding be reduced or eliminated?

Yes. A foreign seller can apply to the IRS for a withholding certificate that reduces or eliminates the withholding, including where the transaction qualifies for nonrecognition treatment such as a 1031 exchange. This is typically done using Form 8288-B.

If the application is filed before or at closing, the buyer or escrow agent can generally hold the withheld amount rather than remitting it until the IRS responds. Once the certificate is issued, the reduced amount is remitted and the rest can be released.

How long does the certificate take?

The IRS aims to process applications within a set period, commonly cited as around 90 days after receiving a complete application, but processing can take longer. That is why applications need to be prepared early, ideally before or as soon as the property is under contract.

If funds are held pending the certificate, they may not be available for the replacement purchase until the certificate is issued, which can create timing pressure within the 180 day exchange period.

What information does the application need?

Generally, details of the seller, the property, the transaction, the basis and expected gain, and an explanation of why the withholding should be reduced, such as the transaction being part of a like kind exchange. The seller also needs a US taxpayer identification number, which foreign sellers sometimes do not have. Obtaining one can itself take time.

Are there other considerations for foreign exchangers?

• ›US property for US property only. Real property in the United States is not like kind to property outside the United States, so a foreign investor cannot exchange a US property into property abroad.
• ›State withholding. Some states have their own withholding rules for nonresident sellers.
• ›Entity structure. Foreign investors often hold US property through entities. The rules differ depending on whether the seller is an individual, a foreign corporation or another entity.
• ›Tax returns. The foreign seller must file a US return reporting the exchange, even if no tax is due.

What does a worked example look like?

A foreign investor sells a US apartment building for 3 million dollars and plans to exchange into another US property. Without a withholding certificate, the buyer must withhold 450,000 dollars, 15 percent of the price.

If the seller files Form 8288-B before closing, the escrow agent can hold the 450,000 dollars pending the IRS decision. If the IRS issues a certificate reducing withholding to nothing because the exchange defers the gain, the escrow agent can release the funds, and they can be used in the exchange.

If the certificate takes longer than expected, the seller may need other funds to complete the replacement purchase on time, or risk a partial exchange. That is why the application should start as early as possible.

Does an exchange eliminate US tax for the foreign seller?

It defers it, as it does for US investors. The deferred gain carries into the replacement property. When the foreign investor eventually sells without exchanging, FIRPTA withholding and US tax will apply to that later sale. Planning for the eventual exit, including how the property is held, is an important part of the strategy.

What should a foreign seller do first?

• ›Obtain a US taxpayer identification number if you do not have one
• ›Engage a CPA experienced with FIRPTA and exchanges before listing
• ›Prepare Form 8288-B early, ideally when the property goes under contract
• ›Coordinate with the escrow agent and Qualified Intermediary on how withheld funds will be held
• ›Plan how to fund the replacement if withholding funds are delayed

Nothing here is tax, legal or investment advice. FIRPTA and exchange rules are technical and depend on your circumstances. Confirm your position with a CPA and attorney experienced in international real estate.