A Background On FIRPTA
In the late 1970’s, a group of foreign investors sold Rockefeller Center in New York City at a substantial profit. Under Federal tax law at that time, the capital gain was not “effectively connected” with a US trade or business, and accordingly it was not subject to US Federal income tax. Congress responded to this inequity by enacting the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), which treats the gain from sale of US real property interests since that time as “effectively connected” with a US trade or business, and therefore subject to Federal income tax.
In 1984, Congress enacted some changes to FIRPTA, most significantly requiring a buyer or transferee to withhold 10% (now 15%) of the purchase price or fair market value of the United States real property interest (not just the gain). Although the sale or other disposition itself requires filing of a US income tax return (1040-NR, 1120-F, etc.) for the year of the sale or other disposition, this withholding induces foreign sellers to file these Federal income tax returns to claim a refund of FIRPTA withholding intentionally designed to exceed the typical Federal income tax due. By making the 10% (now 15%) a withholding tax imposed on the buyer (who can typically be found at the property address after the closing), the IRS is now much better equipped to collect FIRPTA withholding and the actual Federal income tax on the gain. The chances of success are much higher than the outcome of merely relying on a foreign seller to voluntarily file a Federal income tax return after the year of closing with a large check payable to the US Treasury.
New York and many other states have enacted similar withholding or estimated tax regimes for real property sales, not only on foreign persons but also on residents of other states selling property in the state at issue. Most or all of these look to impose their maximum income tax rate on the estimated net gain from the transaction, rather than FIRPTA’s arbitrary percentage of sale price that may not closely correlate with any actual gain.
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