What is FIRPTA? A Comprehensive Guide for Real Estate Professionals in California

Foreign property ownership in the United States has grown significantly over the years, particularly in California, a state known for its desirable real estate market. However, when it comes to selling property, foreign owners must navigate unique tax regulations under the Foreign Investment in Real Property Tax Act (FIRPTA). This comprehensive guide explains FIRPTA's purpose, its impact on real estate transactions, and why understanding its requirements is essential for professionals like real estate agents, title companies, and attorneys in California.

Table of Contents:

1. What is FIRPTA?
2. How Does FIRPTA Work?
3. Who Does FIRPTA Apply To?
4. Understanding FIRPTA Withholding Rates
5. Steps for Compliance with FIRPTA
6. FIRPTA Exemptions and Reductions
7. Documentation Required for FIRPTA Compliance
8. Common FIRPTA Mistakes to Avoid
9. How FIRPTA Affects California Real Estate
10. Why Partner with FIRPTA Solutions

1. What is FIRPTA?

The Foreign Investment in Real Property Tax Act (FIRPTA) is a federal law enacted in 1980 to ensure that foreign property sellers in the U.S. pay their fair share of taxes on gains from the sale of real property. Under FIRPTA, the buyer must withhold a percentage of the sale price to cover potential taxes owed by the foreign seller.

Key Takeaways:

• FIRPTA applies only to non-U.S. residents selling real property in the U.S.
• It shifts the tax compliance burden to buyers to ensure tax collection.
• The withheld amount acts as a prepayment of the seller’s U.S. tax liability.

2. How Does FIRPTA Work?

When a foreign individual sells U.S. real estate, FIRPTA requires the buyer to withhold a specific percentage of the sale price. This amount is sent to the Internal Revenue Service (IRS) as an advance payment of the seller's tax liability.

The withholding ensures that the IRS collects taxes even if the foreign seller doesn’t fulfill their tax obligations post-sale.

Example Scenario:

• Property Sale Price: $1,000,000
• FIRPTA Withholding Rate: 15%
• Withholding Amount: $150,000

The $150,000 is remitted to the IRS by the buyer or withholding agent. The seller can later claim a refund if the withheld amount exceeds their actual tax liability.

3. Who Does FIRPTA Apply To?

FIRPTA applies to any foreign person or entity selling U.S. real property. Here’s a breakdown of who is considered a "foreign person":

• Non-resident aliens: Individuals who are not U.S. citizens and do not pass the substantial presence test.
• Foreign corporations: Companies not incorporated in the U.S.
• Foreign partnerships, trusts, or estates.

Exemptions:

• S. citizens, green card holders, and entities registered in the U.S. are not subject to FIRPTA.

4. Understanding FIRPTA Withholding Rates

The withholding rate depends on the sale price and property use:

5. Steps for Compliance with FIRPTA

Step 1: Determine FIRPTA Applicability

• Verify the seller’s residency status.
• Confirm if the sale qualifies for an exemption (e.g., buyer’s use as a primary residence).

Step 2: Calculate the Withholding Amount

• Use the total sale price to determine the withholding percentage.

Step 3: File IRS Forms

• Ensure all necessary IRS forms are completed: and submitted in compliance with FIRPTA regulations.
• Consult a tax professional: or contact FIRPTA Solutions to avoid errors and ensure accurate filing.

Step 4: Send Withholding to the IRS

The withholding must be sent within 20 days of the property transfer date.

Step 5: Provide Documentation to the Seller

The seller will need proof of withholding for tax reporting and potential refunds.

6. FIRPTA Exemptions and Reductions

Exemption Scenarios:

• Buyer’s Residency Intent: Sale price below $300,000 with buyer’s affidavit of residency.
• Certificate of Reduced Withholding: Sellers can apply for reduced withholding by submitting the proper IRS tax form before the sale closes.

Common Reduction Mistakes:

• Delays in filing necessary tax forms.
• Insufficient supporting documents.

7. Documentation Required for FIRPTA Compliance

• Seller’s Tax Identification Number (ITIN): Essential for tax reporting.
• Buyer’s Affidavit (if applicable): To claim primary residence exemption.
• Proper IRS Tax Forms: For reporting and remitting withholding. Contact Us if you need help with the proper tax forms!
• Proof of Payment: To validate IRS compliance.

8. Common FIRPTA Mistakes to Avoid

1. Failure to Withhold Correctly

• Miscalculating the withholding amount can result in penalties.

2. Delays in IRS Submissions

• Withholding and documentation must be submitted within strict deadlines.

3. Ignoring ITIN Requirements

• Sellers must have an ITIN to complete the process.

4. Overlooking Reduced Withholding Opportunities

• Sellers may qualify for a reduced withholding certificate but fail to apply.

9. How FIRPTA Affects California Real Estate

California’s competitive market and high property values make FIRPTA compliance even more critical. Real estate professionals play a pivotal role in ensuring transactions comply with federal regulations.

Key Considerations:

• High property values often trigger the 15% withholding rate.
• Non-compliance can delay escrow and jeopardize deals.

10. Why Partner with FIRPTA Solutions

FIRPTA compliance can be complex, especially for high-stakes California transactions. FIRPTA Solutions specializes in:

• ITIN Application Assistance: Streamlining the process for foreign sellers.
• Reduced Withholding Applications: Ensuring sellers don’t overpay.
• Expert Guidance: Helping real estate professionals navigate FIRPTA requirements with confidence.

Learn more about FIRPTA Solutions services and how they can simplify your transactions.