The IRS would like to make sure that anyone who sells real estate in the United States pays any tax that is due on the gain. It is very difficult to force someone in another country to pay U.S. taxes after they have received their funds, and especially if they have no other U.S. source income.

Buying a home from a non-U.S. resident

Dan A. Mace, CPA

In today’s hot real estate market, it seems like houses are being sold faster than realtors can get them listed and selling at record high amounts. Combine that with Covid-19 restrictions over the past year, and you have a perfect storm of non-U.S. residents deciding to sell Arizona vacation homes they’ve been unable to travel to for over a year.

On the surface, this does not seem to be an issue for the purchaser of the house. Why should you care if the prior owner of your dream house was a U.S. resident (aka a U.S. Taxpayer)? Well, the IRS would like to make sure that anyone who sells real estate in the United States pays any tax that is due on the gain. It is very difficult to force someone in another country to pay U.S. taxes after they have received their funds, and especially if they have no other U.S. source income.

Don’t miss: Tax impact of buying real estate in a foreign country

To ensure that the foreign seller pays their taxes, congress passed the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA). This is where, as the buyer, you must be aware of your responsibilities. If you are buying from a foreign person, you are required to withhold income taxes on the gross sales price of the transaction. If the buyer fails to withhold, they may be held liable for the tax. And we are not talking about insignificant amounts here. The default withholding is 15% of the gross sales price. On a $500,000 home, that is $75,000 of tax withholding.

Fortunately, in most Arizona transactions, your title company will make you aware this obligation exists. Note, however, that I have never seen a title company accept responsibility for the withholding or even give advice on exceptions to the withholding requirements. It falls back on the buyer to ensure that they are in compliance with the FIRPTA rules.

In practice, I rarely deal with the buyers in these transactions. It is always the sellers who are concerned with the sometimes unreasonably large withholding on the transactions. After all, when the money is withheld, it can take over a year to get excess withholding refunded from the IRS. We have had great success applying for reduced withholding certificates to get withholding reduced to a more reasonable amount based on the seller’s actual tax liability on the transactions.

The rate of withholding can also be reduced depending on the buyers intended use of the property and the selling price. In fact, if you are buying a house for personal use and paying less than $300,000, there is no FIRPTA withholding at all.

Don’t miss: State taxes on capital gains

Points to remember:

  • The BUYER is responsible for FIRPTA withholding when buying real estate from a foreign person unless an exception exists.
  • The amount of the withholding may be reduced if the seller qualifies and all parties to the transaction (buyer, seller and title company) agree to the reduced withholding application process.
  • If the buyer fails to withhold when required under FIRPTA, the buyer (withholding agent) will not only be liable for tax withholding but will also be assessed high interest and penalties.

As the buyer, if a foreign seller wants to reduce (or even eliminate) withholding under FIRPTA, you need to make sure that you protect yourself in the transaction. Be sure to discuss the situation with the title company and your trusted advisor. You may even want to have your advisor speak with the professional that the seller is using to prepare the reduced withholding forms to make sure that they have the experience necessary to complete all the forms and ensure that any withholding at lower than the default rates is properly documented. Most importantly, the title company will need to agree to holding escrow open until the reduced withholding is approved by the IRS.

If you discover that the seller of your dream house is not a U.S. resident, be sure that you understand your responsibilities and contact your Henry+Horne advisor to make sure you are protected in the transaction.

Dan A. Mace, CPA, Partner, specializes in providing tax services to small businesses, individuals and nonprofit organizations. You can reach him at (520) 836-8201 or DanM@hhcpa.com.