A foreigner does not have to have a green card, permanent residence status or a Tax Identification Number (TIN) in order to make a real estate investment in the United States. So foreigners are mostly unaware that their investment might result in a tax liability for them. The issue usually arises when they are ready to sell their investment. There are 2 income tax withholding requirements that foreign investors face upon disposition of real estate: one on the federal level and one on the state level.
In order to effectuate the sale of the real property, every seller is required to sign, under penalty of perjury, the Foreign Investment in Real Property Act (FIRPTA) disclosure form which states that the Seller is not a “nonresident alien”, ie, not a foreign person. The FIRPTA makes it a Buyer’s responsibility to withhold 10% of the sales price from the seller and send this amount to the IRS within 20 days from the day of closing to avoid incurring penalties. Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests and Form 8288A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests are generally used for reporting and paying the tax to the IRS.
State of California Real Estate Withholding
For the State of California, the law states that all real property being sold requires the payment of tax in an amount equal to 3.33% of the gross sales price with Form 593 Real Estate Withholding Tax Statement.
However, the State will allow sellers to calculate income tax withholding based on realized gain amount using maximum applicable tax rates:
- Individual 12.3%
- Non-California Partnership 12.3%
- Corporation 8.84%
- S Corporation 13.8%
Form 593-E, Computation of Estimated Gain or Loss, is required to be used to calculate the amount to withhold and appropriate box needs to be checked on the form.
How to get tax withholding back?
A TIN from the foreign seller is needed in order to properly do the withholding. If the seller doesn’t have one, it can be obtained by submitting form W-7 to the IRS . In case of foreign corporations or partnerships, Form SS-4 will have to be filled out and submitted to the IRS in order to obtain a FEIN.
At the end of the fiscal year, the foreign seller must file his or her income tax return to report the gain on the sale of real estate. Copies of submitted Forms 8288A and 593 will have to be attached to the returns in order to substantiate the withholding. If the withholding was made for the amount that exceeded the actual tax liability, the IRS and FTB will refund the difference to the foreign seller.
Application for the Reduced Withholding
The sellers are permitted to request the IRS to reduce the amount of the withholding to actual tax liability. In order to do so, Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of US Real Property Interests needs to be submitted to the IRS before or on the date of a transfer. This application will have to contain a calculation of the maximum tax liability along with the supporting documents to substantiate these calculations. IRS has 90 days to either approve the application. The tax withholding will then have to be paid to the IRS within 20 days following the day on which a copy of the withholding certificate or notice of denial is mailed by the IRS.
Form 8288-B also requires the seller to have either a US Federal Employer Identification number (FEIN) if the seller is a business entity or a ITIN (SSN) if the seller is an individual. FEIN will have to be obtained prior to submitting the application for the reduced withholding. ITIN requests can be submitted together with the application.
For more information about real estate withholdings for foreign investors please call LSL CPAs at 714.569.1000.
By Summer Zhu, CPA