When a taxpayer realizes a gain on the sale of property, the taxpayer typically owes capital gains taxes on the amount realized. One method often utilized by taxpayers to avoid the payment of capital gains taxes is to enter into a Section 1031 Exchange instead of a traditional sale. When a transaction qualified for Section 1031 treatment the capital gains taxes that would otherwise be due are deferred. When a non-resident alien, or foreign, investor is involved the rules become a bit more complicated.
FIRPTA
Under the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA, a foreign investor in real estate located in the United States is required to pay income tax on any realized gain upon the sale of property. Pursuant to the FIRPTA rules, a buyer is required to withhold 10 percent of the sale price at the time of purchase of a property when the seller is a non-resident alien to ensure payment of the tax.
As with many of the tax rules, there are exceptions to the withholding requirement. The following common exceptions to the general rule will eliminate the need to withhold funds:
- The buyer is purchasing the property for use as a home and the amount realized is less than $300,000.
- The property is an interest in a domestic corporation if any class of stock is regularly traded on an established securities market.
- The property is an interest in a domestic corporation and the corporation provides a certificate, signed under oath, stating that the interest is not a U.S. property interest.
- The seller provides a certificate, signed under oath, stating that he/she/it is not a foreign person or entity.
- The seller provides you with a written notice, signed under oath, stating that no recognition of gain is required because a non-recognition provision in the IRS Code applies to the transaction.
- The amount realized is zero.
Along with the above-mentioned exceptions, a seller may apply to the Internal Revenue Service, or IRS, to reduce the 10 percent withholding requirement to the amount actually estimated to be due on the transaction. The IRS frequently approves these requests assuming they are completed accurately and filed in a timely fashion. When a request is approved, the IRS will provide a withholding certificate stating exactly how much is required to be withheld, if any, upon the sale of the property.
Qualified Intermediary Role
In order for a transaction to qualify as a Section 1031 Exchange, the parties must use a Qualified Intermediary, or QI, to facilitate the exchange. The QI will hold the funds used in the exchange as well as the titles to both properties and transfer both to the appropriate parties at the appropriate times. When a non-resident alien enters into a Section 1031 Exchange instead of a traditional sale of property, the QI used to facilitate the exchange will also help ensure compliance with the FIRPTA rules by completing and filing IRS Form 8288-B (Application for Withholding Certificate) as well as completing and submitting IRS Form 8288 (U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interest) and IRS Form 8288-A (Statement of Withholding).
The real estate transaction flows as normal with a couple of additional steps. The QI will suggest to include assignment language in the Purchase and Sale Agreement (PSA) unless the PSA already has the verbiage within the contract as does the Florida Realtors Contract, page 10, line 524. The title company or closing attorney will typically itemize the 10 percent withholding on the second page of the settlement statement and wire those funds to the escrow account established by the QI. The QI will file the necessary forms and the IRS will respond to the QI within three to five months requesting the replacement property settlement statement confirming that a Section 1031 Exchange was completed and the capital gains tax was deferred.
Click the button below to request a complimentary 1031 exchange consultation with a Certified Exchange Specialist© and receive a response within twelve hours or less. The Atlas 1031 Exchange is a member of the Federation of Exchange Accommodators and is subject to an annual criminal background check and Code of Ethics.
