FIRPTA Withholding: What Is It and Who Does It Apply To

Thousands of foreign investors purchase billions of dollars worth of US real estate properties every year. The trend has been going on for decades, and it doesn’t seem like it will stop anytime soon. A thing that many of those tens of thousands of foreign investors have to deal with is the  Foreign Investment in Real Property Tax Act or FIRPTA withholding.

The FIRPTA income withholding was established in 1980 as a means to ensure that foreign investors pay their share of taxes to the US economy. It helps the IRS prevent foreign persons or entities from avoiding or evading taxes. Evading is completely illegal, and avoiding is open to interpretation (depending on the exact situation).  

In this article, we’ll share some basic information about FIRPTA withholding tax. We’ll talk about what it is and under which circumstances it is applicable. We’ll also tell you about the most common exemptions along with and under which conditions you can avoid FIRPTA withholding legally.

Let’s start!  

What Is FIRPTA Withholding?

Foreign Investment in Real Property Tax Act, or FIRPTA for short, is a law that allows the IRS to immediately charge foreigners (i.e., withhold income tax) who participate in the disposition of US real estate. Disposition, in this case, means the sale, transfer, exchange, liquidation, redemption, gifting, or investment in US property. Why is this FIRPTA important to understand, and what’s so different about it?

Generally, taxes in the US are paid once a year, during the tax season, which is usually between January 29 and April 15. It’s important to note that the taxes in the US are paid for the previous year. This means that in 2024, you’ll be paying taxes for 2023, in 2025, for 2024, and so on. 

FIRPTA falls outside of that and allows the IRS to charge taxes immediately after the disposition occurs. Let’s say you’re a foreign investor who bought property in the US in 2020 and has decided to sell it. You close the sale in July of 2023. Normally, you would have to report that sale and pay taxes on capital gains during the 2024 tax season. This additional time allows you to deduct various expenses from your tax bill, effectively giving you the chance to lower it before paying it. 

However, because of FIRPTA withholding and how it works, if you can’t legally avoid it, the taxation process will be different. 

For example, let’s imagine you are selling a property for $400,000. Without FIRPTA, you would be able to deduct any expense you’ve incurred during the time you’ve owned the property (repairs, maintenance, etc) and lower your tax bill before making a payment to the IRS. But, because of FIRPTA withholding, the IRS will immediately charge you a 10%-15% tax of the property’s value (depending on the specifics of your situation) and will not allow you to deduct expenses.  

And then, if you want to get some of your money back, you’ll have to start a lengthy process where the burden of proof is on you instead of the opposite being the case (when you pay taxes the regular way). This means that you’ll have to prove to the IRS that you actually had expenses and have put money into the property before selling it. To do that, you must fill out the FIRPTA form, also called Form 8288.

FIRPTA withholding tax can be legally avoided if the real estate transaction is done under a specific business structure. If you want to learn more, contact us or book a free call.

Why Does the IRS Use FIRPTA Withholding?

The main reason the IRS instituted the FIRPTA withholding tax is to ensure that foreign investors pay their fair share of taxes. 

The US government realized that getting taxes from a person or an entity not directly connected to the US is much more difficult. Because of that, they’ve decided to change their rules about paying taxes. Before FIRPTA, every taxpayer was submitting tax returns for the previous year (Taxes for the year 2022 would be paid in 2023. For 2023, in 2024, and so on). What FIRPTA does is it essentially allows the IRS to take taxes in advance before the foreign seller can deduct anything from their tax bill. And this completely flips the script on the way taxation in the US works:

Instead of taxpayers paying taxes and then the IRS having to prove whether the amount was sufficient or not, with FIRPTA, that burden shifts to the taxpayer. Foreign sellers have to prove every tax deduction so they can get some of their money back. And, as almost everybody knows, the IRS is not so keen on giving refunds. That’s why it’s important to educate yourself about FIRPTA withholding before you do anything as a foreign buyer or seller. It can save you a lot of money and time.

Want to learn all about FIRPTA withholding and how to legally avoid it?

Who Does FIRPTA Withholding Apply To?

FIRPTA almost always applies if the seller is a foreigner; that is, the person or entity receiving the money is of foreign origin. If you’re a foreign investor buying US property, you won’t have to worry about paying FIRPTA taxes. Instead, your role will be to serve as a “withholding agent” and pay a certain percentage of the property’s value directly to the IRS rather than giving it all to the seller. However, the seller of that property will have to think about FIRPTA if they want to get a portion of their money back.  

But, if you’re a nonresident who’s selling US property, you’ll be subject to the FIRPTA act, and the IRS may decide to withhold a percentage of your property’s selling price. In this case, the buyer of your property will act as a withholding agent, and they’ll have to keep a certain percentage of the said property’s price and pay it to the IRS instead of you. 

FIRPTA Withholding Tax: Exemptions

Like most US tax laws and regulations, FIRPTA also has certain exemptions to its rules. Some of those FIRPTA exemptions are:

• If the property is meant for residential purposes and the sale price is less than $300,000, the buyer doesn’t have to withhold any amount of money for the FIRPTA tax.
• If the seller fills out the IRS form W-9 and proves they are not a foreigner
• If the buyer purchases a small amount of equity in the property with the intent of using the said property as a residence and if the buying price doesn’t exceed one million dollars. 
• Foreign governments and pension funds are exempt from paying the FIRPTA withholding tax.
• Investors or sellers from countries that have a tax treaty with the US, such as the UK and Canada.