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DRAFT: Foreign Investors

Foreign Investors

Help for Foreign Investors Who Want to Buy Florida Real Estate

The Five Critical Aspects of the Rule and When They Apply
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) establishes that persons purchasing U.S. real property interests from foreign individuals must withhold 10% of the gross amount realized on the transaction. This rate will be increased 50% effective February 17, 2016 from the previous 10% to 15%.
The Five Critical Aspects of the Rule:
1. This withholding only applies to cases involving a foreign seller (a person whose primary residence for tax purposes is outside of the United States).
2. This is not an actual tax. Rather, it is a measure taken by the IRS in order to ensure the collection of any applicable income taxes from the foreign seller resulting from the sale.
3. As of February 17, 2016, the FIRPTA withholding rate provided for under the law will increase from 10% of the gross sale price to 15%. This 50% rate increase may indicate that property values are again on the rise as that the amount of tax owed generally exceeds 10%.
4. Under U.S. Law, it is the buyer’s responsibility to withhold the proper funds from a foreign seller when purchasing U.S. real estate. If the buyer fails to do so, they can then be held liable for the amount of the withholding. Typically, the buyer’s closing agent will act on their behalf to meet these obligations.
5. FIRPTA protects the buyer. Although the purpose of the law is to ensure that the IRS is able to collect the applicable income tax on a transaction, it has the secondary benefit of protecting the buyer by covering the projected amount for which they will be held liable.
Because the rules for withholding can be cumbersome to understand, it is advisable as always, to take legal or accountancy advice to make sure you comply. It is always better to spend the money up front to make clear what you need to do, rather than deal with any unintended consequences from simply not knowing how it works.
That said, we think it is important to present the information here as clearly as possible in order to familiarize you with the rules and how they apply.
Buyer meets foreign seller: knowing the rules can help you seal the deal
Like many countries, one of the ways the U.S. Government generates its income is by taxing the profits on the sale of real estate investments made within the country. This is a type of capital gains tax, which applies to citizens and non-citizens alike, who sell investment property (the sale of a primary residence is handled differently).
U.S. citizens are subject to this tax as part of their regular income tax. For global buyers, The Foreign Investment in Real Property Tax Act (FIRPTA) is the mechanism that sets the parameters for handling the payment of taxes for foreign persons who sell U.S. real estate interests.
FIRPTA: What It Is and How It Works
Essentially, when an individual sells a property in the United States, they are required to file a U.S. income tax return to report the sale. This is where the actual tax on the sale is calculated.
FIRPTA requires that any individual who is selling a property in the U.S. that is not a U.S. citizen will have 15% of the gross sales price withheld at closing. This 15% withholding must then be remitted to the Internal Revenue Service (IRS) within 20 days after closing.
This 15% withholding is considered a deposit that will be applied to the actual tax which is calculated when filing a U.S. income tax return. Upon comparing the deposit and the actual tax, if the tax is less than the 15% withholding, the remainder is refunded to the seller. If the difference is greater than the 15% withholding, the seller must then remit the balance to the IRS.
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The Exception You Need to Know About
No withholding is required provided that the sale price is $300,000 or less and the buyer (including family members) intends to use the property as a personal residence for at least 50% of the time it is in use for a period of 24 months after closing. Days that the property is not in use are excluded from this 50% calculation.
For this to apply, the buyer must be an individual as opposed to a corporation, estate, trust or partnership. Vacant land is not eligible for this exemption even if the buyer intends to build a residence on the property.
As an example, let’s consider that a foreign citizen sells a U.S. property for $285,000. In this example, the buyer intends to use the property as a personal residence for five months out of the year on an ongoing basis. The buyer also intends to rent the property for three months out of each year. During the remaining four months of each year, the property will remain vacant.
Because the buyer intends to use the property as a residence for five out of the eight months that the property is in use during a twelve month period and the buyer intends to continue this pattern for more than the required two years, the 50% calculation will be met and the seller qualifies for the exemption.
In this example, however, the buyer must be willing to sign an affidavit as to their intentions under penalties of perjury. The seller must still file a U.S. income tax return reporting the sale and pay all applicable income taxes.
Sales exceeding $300,000, whether at a profit or at a loss, do not qualify for an exemption.
When The New 2016 Rules Provide for the Reduction of the 15% Back Down to 10%
The 15% withholding rate may be reduced back down to the prior 10% rate provided that the sale price not exceed $1,000,000 and, as with the exception above, the buyer intends to use the property as a personal residence as described. In this case as well, the buyer must sign an affidavit under penalty of perjury expressing their intentions.
Applying for a Withholding Certificate When Selling at a Loss
Another important piece of information to keep in mind is that, when the actual tax on the sale is significantly less than the 15% withholding, the seller can apply for a withholding certificate from the IRS. This, then, allows for a reduction in the amount withheld at closing from 15% down to 10% of the gross sales price.
To clarify why this is crucial, let’s look at another example. An individual bought a property for $700,000. He is later only able to sell the same property for $600,000. In this case, because the seller is incurring a significant loss on the sale of the property, no income tax is payable on the sale. Still, the 15% withholding is applicable and $90,000 will be withheld on the transaction.
However, in this situation, the seller may submit an application to the IRS documenting that the sale will result in a loss. Provided that the application is made no later than the date of closing, no withholding is required.
Because it generally takes the IRS 90 days to issue the withholding certificate, closing may take place before the certificate is issued. If this is the case, the 15% is deducted at closing. However, instead of remitting the withholding to the IRS, the closing agent is able to hold the money in escrow until the withholding certificate is issued. Upon receipt of the certificate, the agent is then able to remit the reduced withholding amount, if any is applicable, and return the balance to the seller.
Things to Consider When Applying for a Withholding Certificate
Things to consider in deciding to apply for a withholding certificate are how the actual tax compares the withholding amount and the time of year that the transaction takes place. Individual income taxes are reported based on the calendar year.
There is less reason to file for the withholding certificate if the sale takes place in December and the tax return may be filed in the near future. In this case, the funds would be refunded a few months after the sale.
However, if the sale takes place in January, it could be 14 months or more after the sale before the refund is issued. In this case, depending on the amount due, it may be advisable to apply for a withholding certificate.
In considering the terms of a short sale, where the amount due on the existing mortgage will not be met from the proceeds of the sale, the 15% rule still applies on a property with a sale price over $300,000. In this case, it would be advisable to apply for the withholding certificate as any withholding would reduce the amount paid to the lender at closing. Without it, it is unlikely that the lender would approve the sale.
In order to apply for a withholding certificate, all parties involved in the transaction must have a Tax Identification Number (TIN) or a U.S. Social Security Number. This is extremely relevant for the Foreign Investor because it provides for the opportunity to obtain a U.S. TIN. The only other way for a Foreign National to get a TIN is by renting their property.
What is the Foreign Investment in Real Property Tax Act (FIRPTA)?
A look at the property tax law that comes into play on the sale of real property owned by a foreign seller.
The Foreign Investment in Real Property Tax Act (FIRPTA) is a tax imposed on the amount realized from the sale of real property owned by a foreign seller.
• There are exceptions to this tax-withholding requirement. Given the complexities of tax laws, the buyer and seller should consult with a tax specialist to determine the exact withholding amount or to determine if an exemption to the FIRPTA requirement applies.
• FIRPTA applies when the seller is a foreign person, as defined by FIRPTA. However, a foreign buyer may want to consult with a tax professional if that buyer’s intent is to sell the property, as then FIRPTA may apply.
• As there are several exemptions available, foreign sellers are wise to speak to their tax professional as early in the sales process as possible to know their options to avoid money being held in escrow.
Structure of a Foreign Investor
When you have a foreign investor in U.S. real estate there are other things that you need to consider that are critical. One is the structure of the buyer. Is it a foreign individual just buying property in their own name which is almost never the right thing to do. Because you can immediately subject that foreign individual to U.S. tax laws and tax liabilities. Does the individual already have a foreign entity, a foreign corporation or a foreign trust and there are lots of entities overseas that we don’t have here in the United States. Do they want that entity to buy the property. Again, that’s usually never going to be the case.
The most common is probably that that foreign entity create a United States or a Florida limited liability company so it is a Florida domestic limited liability company. The owners of which are a foreign entity and then the foreign entity is owned by the individual foreign investors.
Building a Relationship with a Bank
Another critical issue is banking relationships. People who live here in the United States that are buying property 99% of the time they already have pre-existing banking relationships. When it’s a foreign investor coming into the United States 99% of the time they don’t have any U.S. banking relationships. In fact we find that about 80% of real estate purchases are paying all cash when they’re foreign purchasers.
If there is going to be financing setting up a banking relationship is a critical first step. It’s a little late after you’ve already signed the contract for the property and now you’re scrambling around with maybe 30 or 45 days before closing trying to find financing. So that banking relationship needs to be setup prior to the actual going out and contracting the party.
And in our post-911 world it’s a lot different than it used to be. You can’t just walk into the bank, shake hands, let’s open a bank account, there’s all types of background information, background checks under the Patriot Act that have to be done.
So it’s a very good scenario if someone is a foreign investor that they work with a U.S. attorney who can typically take them into a bank, introduce them. The lawyer already has a pre-existing relationship with the bank, knows the bankers and they can trust the lawyer in terms of who the lawyer is bringing to them as a potential customer.
Visas Important for Foreign Buyers
There’s also the issue of visas. You know many people come, we’ve had many many people come in, they’re on a tourist visa, they want to snatch up some foreclosure properties in Florida because it looks like good deals in terms of exchange rates and the relative value of the properties and they want to snatch them up. And you’ve got to have a lot of conversations about look you’re here on a tourist visa.
First of all even with that type of visa, if you spend too much time in the United States you can start subjecting yourself to U.S. taxes. And is your use of the property consistent with the type of visa that you have. If you are going to buy the property and get on a plane, fly home and just use a property manager to operate it, well, maybe getting in and out on a tourist visa will be alright. But if it’s going to be a property where there’s going to be hands on management activity you’ve got to make sure you’ve got the right type of visa before you go out and commit yourself into property purchases.
Foreign Investors Need a U.S. Attorney
These are critical steps that all must be taken by foreign investors. We’re talking about corporate law, real estate law, tax law, immigration law, all of these areas. Now it’s obvious that no one person can handle all of these things but what a foreign investor needs when they come into a community is that they need to develop a relationship with somebody.
And I’m obviously, as an attorney, it’s my opinion that that somebody should be an attorney. An attorney who has connections in the banking industry, the real estate industry, has a good relationship with an immigration lawyer so that they can take that foreign investor and basically act as the group leader to insure that all of these areas are covered and that all of them are covered correctly so that lawyer may not be an expert in immigration law but he knows enough about it that when he talks to the immigration lawyer and the lawyer says we need to do this or we need to have this type of visa the lawyer knows whether or not that makes sense and that it’s consistent with what his client is trying to do.
Banking Relationships And the same with a banking relationship, the same with a real estate relationship. You can’t come into the United States on an airplane, pick up the real estate magazine in the motel or get online and Google Orlando realtors and going to find yourself with a realtor who has some background and expertise in the type of property you want in the area where you want to be and dealing with foreign investors. You’re not going to get that on Google and you’re not going to get it in the real estate magazine that’s in the hotel lobby. You’re going to need someone who as a group leader who can bring all of these professionals together so that you know that all of the professionals you’re working with have been properly vetted and separated out from the pack.
One piece of advice I would give to any foreign investor coming to invest in Florida. In fact I would say any non-local investor coming to invest in this area. Never rely on the seller of the property to be your guide. Never rely on the seller’s realtor to be your guide. Remember their job, their goal, is to sell the property. It is not to look out for you. You need to make sure that the person that you retain has one goal and that’s to look out for you.