New FIRPTA Withholding Regulations May Complicate Real Estate Closings
By Jonathan H. (Jason) Warner, Miami, Florida*
On August 4, 2003, the Internal Revenue Service issued final regulations requiring changes in closing procedures for real estate transactions involving foreign sellers. Real estate attorneys must:
- Amend their non-foreign certification forms for entities. This change applies to all closings after September 4, 2003, in which the seller is an entity, whether foreign or domestic.
- For all closings after November 3, 2003, in which the seller is a foreign individual or entity, require a U.S. taxpayer identification number to be supplied by the seller (and by the buyer, foreign or domestic) at the time of filing any form, notice or election under Internal Revenue 26 U.S.C., Secs. 897 or 1445. This may cause delays or difficulties in closings, since many foreign owners of U.S. real estate do not have taxpayer identification numbers, and it can take substantial time to obtain one.
- For deferred like-kind exchanges after September 4, 2003, require that a withholding certificate be obtained to verify that withholding is not required.
26 U.S.C., Sec. 897 was enacted as the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), for the first time generally imposing U.S. federal income tax on dispositions of U.S. Real Property Interests (USRPIs) by foreign persons. After Treasury was rebuffed in its attempts to enact a rigorous withholding system to enforce FIRPTA, the Florida Bar's Tax Section proposed a moderate, rational withholding system that enabled real estate transactions to proceed relatively unimpeded. Enacted as 26 U.S.C., Sec. 1445 by the Tax Reform Act of 1984, that proposal's innovative withholding procedures now are replicated in other federal tax withholding areas.
When a foreign person disposes of a USRPI,
the transferee must withhold ten percent of the
amount realized by the transferor at closing and
remit the withheld amount to the IRS no more
than 20 days after the transfer. To avoid excess
withholding when the required amount exceeds
the tax actually due, the transferor may file an
application for withholding certificate (Form
8288-B, generally) with the IRS prior to closing.
If at closing the transferor provides the
transferee a notice that the transferor has
applied for a withholding certificate, the
transferee retains the withheld amount (generally
in an escrow arrangement with counsel)
pending receipt of the IRS approval or denial
of the application. The IRS is supposed to act
on withholding certificate applications within
90 days of receipt, but that seems to have
become a mere aspiration.
If the IRS approves a lesser amount of withholding, the transferee remits that lesser amount (if any) to the IRS with Form 8288 (including Form 8288-A) within 20 days of receipt of the IRS response and refunds the balance of the withheld amount to the transferor. The IRS stamps a copy of Form 8288-A and mails it to the transferor for inclusion in the transferor's U.S. federal income tax return reporting the sale.
These forms and other notices and elections relevant to FIRPTA withholding already call for the TIN of the transferor and transferee. However, if the transferor or a foreign transferee did not already have a TIN, the prior regulations and forms accepted "Applied For" in lieu of the TIN and the transferor's TIN was not required to be provided until the transferor filed its U.S. federal income tax return reporting the disposition of the real property interest.
New Regulations Accelerate Requirement to Provide TINs
The regulations under 26 U.S.C., Secs. 6109, 1445 and 897 now are amended to require a foreign person to provide a TIN at the time of filing any return, statement or other document required by the regulations under 26 U.S.C., Secs. 897 or 1445 for a disposition of a USRPI occurring after November 3, 2003. If the transferor's TIN is not timely provided, the transferee still must report the withholding on Form 8288 and remit, but the transferor cannot obtain a credit or refund of tax on the basis of a Form 8288-A that does not include the transferor's identifying number. The Explanation of Revisions (the Explanation) states that the IRS will consider as incomplete and will not process a withholding certificate application or any other notice or election under 26 U.S.C., Secs. 897 or 1445 that lacks either party's TIN. The amended regulations state that an application for withholding certificate will be denied if not complete, including TINs.
The IRS notes in the Explanation that it believes that the revised regulations do not impose a new obligation on a foreign person but rather accelerate the current requirement to provide a TIN in connection with the transferor's tax return reporting the disposition, or a transferee's withholding return in connection with the acquisition, of the USRPI. Accelerating the requirement for TINs better allows the IRS to identify foreign taxpayers and to more easily match applications, withholding tax returns, notices, and elections with the transferor's income tax return.
Potential Adverse Impact on Real Estate Closings
Foreign owners of USRPIs often are unaware until immediately before closing of the FIRPTA withholding requirement or the requirement to provide a TIN. In this writer's experience, Florida real estate contract forms frequently do not provide a foreign party with adequate notice of these procedures and FIRPTA compliance rarely is considered at the time of contract. A sample Addendum follows this Article.
The current delays and difficulties in
obtaining an ITIN for a foreigner will preclude
filing a withholding certificate application for
many foreign transferors unless initiated at the
time of contract, and perhaps not even that
lead-time is adequate based on recent anecdotal
evidence. Unless the ITIN procedure is improved
or alternative procedures developed
immediately, it may be necessary to advise
foreign clients who own or who may wish to buy
U.S. real estate to obtain ITINS in advance even
if not otherwise needed.
Absent a swift and sure procedure for foreign
parties to obtain an ITIN, the new requirement
may delay or disrupt real estate closings. Some
foreign transferors may suffer excess withholding
at closing, perhaps even having to put up
additional cash when the net proceeds are less
than ten percent of the purchase price. The
transferor cannot utilize even the early refund
application procedure until TINs are available
for both transferor and transferee.
In the explanation, the IRS expressed its
belief that in many cases, the foreign taxpayer
already will have a TIN due to having filed a
U.S. tax return. Other than for rental property,
that belief seems somewhat dubious. The IRS
also expressed the belief that foreign
corporations can obtain employee identification
numbers (EINs) without delay through existing
procedures, but there remains a serious
question whether Form SS-4 requires the
principal officer of an applicant U.S. or foreign
corporation to have a TIN.
The explanation notes that the IRS is exploring options to address concerns about the time it takes nonresident aliens to obtain ITINs, and specifically is considering processing applications for withholding certificates in conjunction with TIN applications. The Instructions to Form W-7 suggests that it takes four to six weeks after filing to obtain an ITIN, but anecdotal evidence suggests that the process is slower and more difficult even when an "acceptance agent" is used rather than mailing the Form W-7 to the IRS or visiting a domestic IRS Taxpayer Assistance Center or a foreign IRS office (not all of which accept these forms). It would not be surprising if the November 3 effective date is delayed further to allow time to implement a better system.
Other Problem Areas with TINs
The amended regulations fail to provide a procedure
for foreign persons to use to supply their TIN
to the other party. It may be assumed, but
should have been explicitly stated, that the TIN
may be provided on Form W8-BEN.
The amended regulations also fail to provide
any sanction or relief for circumstances where
one party fails to provide its TIN timely. For
example, if a transferee refuses to provide its
TIN to the transferor in time to allow the
transferor to file for a withholding certificate
before closing, the transferor might suffer
excess withholding and substantial delay in
obtaining a refund, in some cases having to
provide additional cash at closing if the net
proceeds are less than the required withholding.
One might imagine a transferee using excess
withholding as leverage to force concessions
from a transferor.
A foreign transferee will need its own TIN within 20 days following closing to avoid 26 U.S.C. Sec., 6651 penalties for late remittance of the withheld amount and late filing of Form 8288. If the transferor is unable or refuses to supply its TIN, the transferee should file these Form (including Form 8288-A) and remit the withheld amount without the transferor's TIN, even though the forms will not be processed. But it is not clear that so filing exempts an innocent transferee from all penalties for not obtaining the transferor's TIN. The regulations should state explicitly that, if the transferee has requested the TIN but the transferor does not timely supply it, the transferee would not be subject to any penalties for filing Form 8288 without the transferor's TIN. This would be consistent with Reg. Section 1.6045-4(l)(2), concerning a settlement agent's request for TINs to be supplied on Form 1099. Potentially applicable penalties include those under 26 U.S.C., Sec. 6721 for failure to file a correct information return; 26 U.S.C., Sec. 6722 for failure to furnish a correct statement; 26 U.S.C., Sec. 6723 for failure to comply with other information reporting requirements (including the requirement to furnish a TIN); and 26 U.S.C., Sec. 7203 for willful failure to supply information (including a TIN). Perhaps practitioners should consider inserting in the real estate contract sanctions to be imposed if a party does not provide its TIN when required.
Important Address Changes
The amended regulations update a number of address specifications in the prior regulations. Most 26 U.S.C., Sec. 897 filings previously directed to the Foreign Operations District in Washington, D.C. now go to the Small Business/Self Employed Division in Lanham, Maryland, or to the Philadelphia Service Center at the FIRPTA unit's address. For 26 U.S.C., Sec. 1445 purposes, written communications to the Philadelphia Service Center now go to the address of the FIRPTA unit, and the address for filing Forms 8288 and 8288-A and remitting is changed from the Philadelphia Service Center to the address specified in Form 8288, currently the FIRPTA unit.
Disregarded Entities; Time to Revise Non-Foreign Affidavits for Entities
Effective September 4, 2003, a disregarded entity (for example, a single-member limited liability company) owning a USRPI will not be treated as the transferor under 26 U.S.C., Sec. 1445. Instead, the owner of the disregarded entity now will be considered the transferor. Consequently, a U.S. disregarded entity cannot provide a certificate of non-foreign status, and the entity's owner must give the non-foreign certificate if eligible to do so. Non-foreign certifications for entities will be required to state that the entity is not a disregarded entity. A revised sample statement is provided in the regulations and a copy of that sample language is provided below.
A potential problem with the provision of the non-foreign certification by the owner of a disregarded entity is that the withholding agent might balk at accepting the certificate from a person who has no legal status in the transaction despite the regulatory requirement that the owner give the certificate. Unfortunately, the regulations did not include an affirmative statement entitling the withholding agent to rely on the owner's certification and TIN. Practitioners might revise their non-foreign certificate form to state that the person providing the certification is the owner of the disregarded entity, and that the notice is provided on behalf of the transferor pursuant to the amended regulations.
Another potential problem is that many disregarded entities have TINs different from that of the owner. Using the owner's TIN for FIRPTA purposes is inconsistent with the requirement of Form 1099-S under Reg. Section 1.6045-4 that the disregarded entity's TIN be used. The IRS should address this inconsistency.
Deferred Section 1031 Exchanges Restricted after September 4
The final regulations adopt the IRS position that the expedited non-recognition notice procedure of Reg. Section 1.1445-2(d)(2) does not apply to a deferred 26 U.S.C., Sec. 1031 like-kind exchange because the transferee cannot be sure at the time of closing that the transaction eventually will qualify for non-recognition treatment under 26 U.S.C., Sec. 1031 (for example, if the 45-day identification time limit or the 180-day transfer limit is not met) or that it will qualify as entirely tax-free (for example, if cash or other boot is received by the foreign transferor). Instead, to avoid putting up cash equal to ten percent of the amount realized and seeking a refund, the transferor can apply for a withholding certificate. Although not specifically addressed by Reg. Section 1.1445-3, the IRS long has accepted withholding certificate applications for deferred like-kind exchanges and this procedure now is incorporated into the regulations.
Apparently, the IRS has accepted non-recognition notices in connection with deferred exchanges for years without objection. Proponents of this simpler mechanism for deferred exchanges argued that the IRS should adopt a notice of intent approach similar to that used under Temp. Reg. Section 1.1445-9T(b)(6) (prior to the repeal of 26 U.S.C., Sec. 1034) for replacement of a principal residence.
In connection with formal adoption of the withholding certificate procedure for deferred like-kind exchanges, it is unclear how the IRS will apply the provisions of amended Reg. Section 1.1445-3(b)(2) if the requirement to identify "all the parties" to the transaction extends to the transferor of the replacement property. Often, the identity of such transferor is not established at the time of the initial transfer in a 26 U.S.C., Sec. 1031 deferred exchange. Further Reg. Section 1.1445-3(b)(6) seems to contemplate only a cash escrow of the withholding tax. This is inconsistent with prior IRS practice in accepting withholding certificate applications for deferred 26 U.S.C., Sec. 1031 exchange with alternative security such as an irrevocable letter of credit in accordance with Rev. Proc. 2000-35, section 6. Requiring a transferor to obtain and place in an extended escrow additional cash equal to ten percent of the exchange value is an unnecessary hardship. But, considering the Preamble to the Proposed Regulations, it seems likely that the IRS does not intend that these technical issues should hamper withholding certificate applications for deferred like-kind exchanges.
Code Section 121 Transactions
New Reg. Section 1.1445-3(b)(5) details how a withholding certificate may be sought if the non-resident alien occupied the property as his or her personal residence for the requisite time.
*Jonathan H. (Jason) Warner is a member of The Florida Bar and practices taxation, corporate and business law in Miami. He graduated from Louisiana State University with a B.A. and Columbia University with a J.D. Warner is a past chair of The Florida Bar's Tax Section and past president of the Dade County International Affairs Commission.
SUGGESTED NON-FOREIGN CERTIFICATION LANGUAGE FOR ENTITIES
Section 1445 of the Internal Revenue Code provides that a transferee of a U.S. real property
interest must withhold tax if the transferor is a foreign person. For U.S. tax purposes (including
section 1445), the owner of a disregarded entity (which has legal title to a U.S. real property
interest under local law) will be the transferor of the property and not the disregarded entity.
To inform the transferee that withholding of tax is not required upon the disposition of a U.S.
real property interest by [name of transferor], the undersigned hereby certifies the following
on behalf of [name of the transferor]
- [Name of transferor] is not a foreign corporation, foreign partnership, foreign trust, or foreign estate (as those terms are defined in the Internal Revenue Code and Income Tax Regulations);
- [Name of transferor] is not a disregarded entity as defined in §1.1445-2(b)(2)(iii);
- [Name of transferor]'s U.S. employer identification number is ___________; and
- [Name of transferor]'s office address is ______________________________.
[Name of transferor] understands that this certification may be disclosed to the Internal
Revenue Service by transferee and that any false statement contained herein could be punished
by fine, imprisonment, or both.
Under penalties of perjury I declare that I have examined this certification and to the best
of my knowledge and belief it is true, correct, and complete, and I further declare that I have
authority to sign this document on behalf of [name of transferor].
[Signature(s) and date]
SUGGESTED CONTRACT ADDENDUM
THIS ADDENDUM is being executed simultaneously with, in consideration of, and as part of the foregoing Contract for Sale and Purchase by and between ___________________________ as Seller, and ______________________________ as Buyer dated _____________________, 2003. The parties hereby agree as follows:
The parties shall comply with the provisions of Internal Revenue Code Section 1445 and
applicable Treasury Regulations issued thereunder. If the Seller is a U.S. person for Internal
Revenue Code Section 1445 purposes, then on demand of the Buyer and prior to closing the
Seller shall provide the Buyer with a certificate of non-foreign status in the manner provided
in Treasury Regulations Section 1.1445-2. If the Seller provides the Buyer with such certificate,
and if the Buyer is otherwise permitted to rely on such certificate under those Regulations,
the Buyer shall not withhold under Internal Revenue Code Section 1445.
If the Seller is a 'foreign person' as defined by the Internal Revenue Code, the Buyer generally is required to withhold 10% of the gross sales price from the Seller at closing and to pay the withheld amount over to the Internal Revenue Service (IRS) unless an applicable exemption from withholding or a limitation on the amount to be withheld is available. To the extent that the cash to be paid over to the Seller at closing is insufficient to cover the Buyer's withholding obligation, the Seller shall provide to the Buyer at closing cash equal to such excess for purposes of making such withholding payment. If the Seller's federal income tax on the gain is less than the applicable withholding amount, the Seller may make advance application to the IRS for reduced withholding and, if granted, the Buyer shall withhold only the authorized reduced amount. If such ruling has not been received by closing, the parties at closing shall enter into an escrow agreement reasonably satisfactory to the Buyer and Seller pending receipt of the ruling, provided that at closing the Seller shall have the obligation to provide to the escrow agent from the closing proceeds (or from the Seller's other resources if necessary) cash equal to the maximum required withholding, with any excess withholding being refundable to the Seller upon receipt of a favorable ruling from the IRS.
Buyer and Seller understand that the IRS requires the Buyer and the Seller to have a U.S.
federal taxpayer identification number and to supply that number on the foregoing forms. A
foreign individual may acquire an International Taxpayer Identification Number for this
purpose. Since it may take several weeks to receive the number after application and the
IRS will not process these forms without the actual number, a party lacking a TIN is advised
to apply immediately.
IN WITNESS WHEREOF, the parties have executed and delivered this Addendum
simultaneously with the execution of the above-referenced Contract for Sale and Purchase.
Seller:________________________ Seller's TIN:________________________
Buyer:________________________ Buyer's TIN:________________________