Tuesday, April 13, 2021 / by Sheri Jones
This is a great article from a Tax Advisory firm on FIRPTA (Foreign Investment Real Property Tax Act)
If you are a G-4 visa holder or other nonresident, selling your home in the US this year has been tough. The housing market hasn’t been the problem. In fact, home sales have been booming in many areas. Instead, the problem has been getting your expected cash from the sale.
For decades, nonresidents have been subject to significant tax withholding on the sale of their US homes. This means that if you are a nonresident, you only get 85% to 90% of your sales price at closing, less the amount necessary to cover your remaining mortgage and selling costs. The other 10-15% goes to the IRS as tax withholding. If you don’t actually owe much tax on the sale, you can apply for a tax refund the following year. Sure, you get your money back eventually, but the timing can be a problem if you were counting on the cash to purchase another home or to address an urgent need.
If you don’t want to wait until the next year to get your cash back, you can apply to the IRS for a reduced rate of withholding. To do so, you mail an application to the IRS, and your funds are held in escrow until the application is approved.
It was tough for nonresidents to get their cash before COVID-19. Then COVID-19 hit in the US.
In 2020, when COVID-19 hit, it resulted in IRS shutdowns or reduced operations. As a result, the IRS has accumulated a massive backlog of unprocessed mail.
Since the IRS wasn’t processing much of the mail it received, it also wasn’t processing nonresidents’ applications for reduced rates of tax withholding on the sale of their US homes. Those applications have been sitting in IRS mailrooms for months, waiting for processing, review, and approval.
So, although many nonresidents concluded the sale of their homes months ago, 10-15% of their cash has been stuck in limbo in escrow accounts, awaiting the IRS’s review of their applications.
In the remainder of this blog post, we:
Explain the usual tax withholding process further,
Discuss how COVID-19 has affected the process,
Provide guidance for nonresidents considering selling a US property in 2020, and
Outline some of the common challenges related to the withholding process.
What is the normal tax withholding that applies to nonresidents selling homes in the US?
The tax withholding on home sales is often referred to as “FIRPTA withholding.” That’s because it started in 1980, when the Foreign Investment in Real Property Tax Act (FIRPTA) was passed. The purpose of FIRPTA was to ensure that the IRS could collect tax from nonresidents (who typically lived outside the US) on US taxable income, such as on taxable gains from the sale of US property. By mandating tax withholding at the time of sale, the IRS created a cash reserve to cover the tax, in case the nonresident didn’t file a tax return the following year.
FIRPTA withholding applies to non-US citizens who are “nonresidents” for US income tax purposes, including most G-4 visa holders. Under FIRPTA, nonresidents are subject to income tax withholding of 10% or 15% of the gross sales proceeds when they sell their home. Withholding rates depend on the sales price of the property:
15% if the sales price is $1,000,000 or more
10% if the sales price is less than $1,000,000
No withholding if the sale price is less than $300,000 and the property will be occupied as the buyer’s residence (not held as a rental property).
The amount withheld at closing is not the tax on the transaction. The withholding is simply a down payment on the tax. The actual tax is calculated on your tax return the following year, in accordance with US tax rules for the sale of a home. If you have a gain on the sale of your home, and the actual tax on the gain is greater than the withholdings, then you will owe additional taxes when you file your tax return. If the tax on your gain (or loss) is less than the taxes withheld, the IRS will refund the difference to you after you file your tax return.
How do I reduce or eliminate the 10% or 15% withholding?
If you expect the final tax on the sale of your home will be less than 10% or 15% of the sales proceeds, then you can file a Form 8288-B, Application for a Certificate of Reduced Withholding (“Application”) with the IRS. On this form, you indicate the original cost of the house, cost of improvements made, selling costs, and other information to show the expected gain or loss. The IRS will review the gain-loss calculation and expected tax. If the IRS agent agrees that your actual tax will be less than the required 10% or 15% withholding, the agent will issue a Certificate of Reduced Withholding (“Certificate”). This Certificate will either waive withholding completely or authorize withholding at a lower rate, in line with your actual expected tax rate.
To avoid the higher amount of withholding being remitted to the IRS, the seller must file the Form 8288-B Application on or before closing.
Should I file an “Application for a Certificate of Reduced Withholding”?
It depends. The two principal benefits of obtaining a Certificate are:
To make the full funds available for purchase of a new home or for some other purpose, and
To enable you to take advantage of the time value of money (i.e., invest the funds). Otherwise, you are effectively making the IRS an interest-free loan and allowing the US government to invest the funds for its benefit.
The first benefit requires no further explanation. For the second benefit, you should consider whether the time value of money in your hands exceeds the cost and effort of filing an Application.
Example 1: Assume a sales price of $500,000 and closing on December 1. Withholding will be $50,000 (10% x $500,000). The question is, “Does the time value of $50,000 for, say, the 4 months between December 1 and the date you could otherwise obtain a refund (by filing a tax return early next year) exceed the cost and effort to file an Application?” If the money would otherwise be placed in a bank account earning less than 1% interest for 4 months, the answer is likely to be ”no.”
Example 2: Assume a sales price of $1,500,000 and a closing on February 1. Withholding will be $225,000 (15% x $1,500,000). In this case, the question is, “Does the time value of $225,000 for, say, the 14 months between February 1 and the date you could otherwise obtain a refund (by filing a tax return early the next year) exceed the cost and effort to file an Application?” The answer is likely “yes,” especially if the $225,000 is invested, rather than placed in a bank account earning a nominal amount of interest.
What happens if the IRS doesn’t process the Form 8288-B and issue a Certificate prior to closing?
In a normal year (not affected by COVID-19), the IRS requests 90 days to process the Form 8288-B Application and issue a Certificate. Since an Application cannot be filed before you have a signed sales contract, and the time between contracting and closing is usually less than 90 days, it is highly unlikely that you will receive a Certificate before closing. In such cases, the settlement agent is required to withhold the 10% or 15%, but not send the withholdings to the IRS. Instead, the settlement agent places the funds in escrow until the Certificate arrives from the IRS. Once it arrives, the settlement agent sends no tax or a reduced amount of tax (per the Certificate) to the IRS and refunds the rest to you.
How has Covid-19 affected FIRPTA withholding?
As a result of Covid-19, many IRS offices were shut down or transitioned to work-from-home. This resulted in a considerable backlog of unopened mail (see our recent blog post on the IRS mail backlog). As a result, the IRS is taking considerably longer than 90 days to process Applications and issue Certificates. Some have placed the average processing time at 6 to 12 months!
Until the IRS catches up on this processing, we are advising most of our clients NOT to file Applications for Certificates of Reduced Withholding for home sales through December 31, 2020. Currently, you are more likely to get the cash faster by filing your 2020 income tax return in early 2021 than by applying for a Certificate and waiting 6 to 12 months to have it processed.
What are some complications associated with the FIRPTA withholding regime?
Even under normal circumstances, the Application and Certificate process can have its challenges. It helps if you are working with a settlement agent who is familiar with FIRPTA. Often, when the settlement agent is not familiar with FIRPTA, we receive a call around the closing date, requesting that we explain the rules to the settlement agent.
Common questions include:
How much is withheld if the home is owned jointly by a US citizen or lawful permanent resident, and a nonresident alien?
If a taxpayer is a nonresident but makes a special election to be treated as a US tax resident (often to filed jointly with a US citizen or resident spouse), then is that person subject to FIRPTA withholding?
The Application requires the social security numbers (SSNs) or Individual Tax Identification Numbers (ITINs) of both the seller(s) and the buyer(s). What if the buyers refuse to provide their SSNs or ITINs to the seller? This is a common occurrence these days given the prevalence of identity theft.
What happens if the settlement agent is unfamiliar with the FIRPTA withholding rules, especially as they relate to G-4 visa holders, and doesn’t want to put the withholding in escrow?
Each FIRPTA case is unique, and the best approach depends on many factors, including the time of year, IRS processing speeds, access to SSNs and ITINs, urgency of receiving the cash, etc.