Are you looking to sell your U.S. investment property and are a foreigner? Here is what you need to know before you close the sale.
When you sell your home or real estate investment in the U.S. you expect to receive all of your proceeds but the title company hands you a piece of paper – a 1099-S anyone? – instead of 15% of your money. What do you do now?
1. Don’t panic – You can get much of your money back
Back in 1980, the U.S. Congress passed a law (called FIRPTA) which requires a buyer to retain 15% of what is due to a seller of real estate if the seller is not a US person (meaning a U.S. citizen, a “green card” holder or otherwise a resident). The U.S. wants to collect tax on these sales and believe that many non-U.S. persons may not file a U.S. tax return (and pay the tax) unless they have an incentive to do. Thus, they required that 15% of the sale proceeds be withheld.
The title company or buyer is required to withhold this amount (unless you present it with a certificate, which we describe in #5 below) and remit it to the IRS (except in certain circumstances which we also describe in #5 below).
But the good news is that you can file a U.S. tax return for that year (on Form 1040NR), pay 20% of the gain –more on this below- and hopefully get much of the amount withheld back.
2. 20% of Gain versus 15% of Sale Amount
One question we get regularly is: If the tax rate on my gains is 20% and they only withheld 15%, why do I want to file? Won’t I just be paying 5% more?
The difference is that the 20% is on your gain – in other words, the difference between what you spent for the property over what you sold it for – while the 15% is on the entire amount you sold it for.
Very different… let’s review a simplified example:
|Purchase Amount (aka basis)||USD$200,000|
15% of Sale Amount is USD $37,500 while 20% of Gain is USD$10,000. That is a $27,500 difference and well worth filing for a tax refund.
3. If I file a U.S. tax return, will the U.S. tax me on all my income (both U.S. and non-U.S.)?
No. You may have heard that the U.S. taxes on “worldwide income”. This is generally true when applied to U.S. persons. However, if you are not a citizen or resident of the U.S., you will only pay taxes on your U.S. income or gain. Filing a U.S. tax return will not change that.
Further, (1) you won’t have to disclose your non-U.S. income on your U.S. tax return and (2) you won’t have to file a U.S. tax return the following year (unless, again, you have a U.S. income or gain).
4. Next Steps
You should apply for an ITIN (Individual Taxpayer Identification Number) when you first buy U.S. real estate. However, if you forgot to do so, better late than never. As soon as possible, you should apply for an ITIN and provide it to the title company ahead of closing. You can apply for an ITIN by submitting a completed Form W-7 (together with a notarized copy of your passport) to the IRS.
Following the closing (assuming you have an ITIN), the IRS will send you copy B of Form 8288-A to the address in the U.S. that you provide on the closing documents. Following the end of the year, you will file Form 1040NR and claim a tax refund. The IRS then sends you back your refunded amount.
Obviously, these rules and filings are not as easy to follow as we make them sound.
If you are not familiar with these procedures in depth, we suggest you consult with a tax advisor that can help you. The cost of a tax advisor is worth it to get your tax refund.
5. A Few More Details to Consider…
Obviously, taxation of real estate in the U.S. is complex and has all kinds of exceptions and details to consider. A few (though not all) of those details are listed below. We urge you to consult with a tax advisor before and after you sell your U.S. real estate.
Non-U.S. Persons or Foreign Persons. The above procedures apply only to “foreign persons” or “non-U.S. persons”. If you are not a U.S. citizen, a “green card” holder or otherwise a resident of the U.S., you are a “foreign person” for U.S. tax purposes.
Residence versus Investment Property. The requirement to withhold applies to investment property, and not to residences. Thus, if you sell your second home in the U.S., the buyer or title company should not withhold (assuming you meet certain criteria and deliver appropriate documentation).
Holding U.S. Real Estate through Entities. There are additional rules to consider if you hold U.S. real estate through a corporation, trust, partnership or other entity. Please consult with your tax advisor if you hold U.S. real estate through an entity.
Rental Income. In this article, we’ve only discussed what to do on the sale of your U.S. real estate. If you have a rental real estate in the U.S., you also should file tax returns annually to report net income or loss that you have from this investment property.
Please note that if the property you sell was a real estate investment property, you need to be up to date (meaning you need to have filed a tax return for each year while you owned the property) to receive the tax refund on the sale proceeds.
FIRPTA Certificate. There is a way to avoid having the 15% withheld. In particular, at or before the closing, you deliver a completed Form 83288-B to the buyer or title company. That will cause the buyer or closing agent to hold the amount withheld from you.
Separately, you will want to send a copy of the Form 83288-B, a copy of the settlement statement from the sale of the property and copies of the tax returns for years which you held the property for investment. Once the IRS confirms the accuracy of the Form and other documents, it will issue a Withholding Certificate. Based on that certificate, the buyer or title company can then release the withheld 15% to you.
Please note you still must file a U.S. tax return (and pay taxes) by the appropriate dates. The principal benefit of this approach is that that 15% of sales proceeds is likely released to you sooner.
Depreciation Recapture. If your U.S. real estate is an investment property, you are entitled to depreciate the property each year. In some cases, you can depreciate the property on an accelerated basis resulting in lower taxable income and tax while you own the property. When you sell it, however, if you have taken more depreciation than “regular depreciation” (meaning have taken “accelerated depreciation”), you must pay taxes on the “recaptured depreciation”. It is essentially undoing some of the depreciation expense you took in prior years.
Joint Ownership. If the property transferred was owned jointly by the U.S. and foreign persons, the amount realized is allocated between the transferors based on the capital contribution of each transferor.
Estate Planning. When deciding in whose name to purchase a U.S. real estate property do not forget to consider the U.S. tax implications if you die. These implications are beyond the scope of this article but please consider them before making the investment.