Winter Park Home, Volume 7 / Issue 3, 2009There is a significant hidden federal tax lien that may attach to real property conveyed by a foreign Seller. It may not turn up in a search of the public records and, ultimately, impose an obligation on the Buyer to pay a portion of the Seller’s income tax obligation.
Congress passed the Foreign Investment in Real Property Tax Act (“FIRPTA”) in 1980. This law was enacted to enable the federal government to prevent foreign sellers from escaping the income taxes on transfers of real property situated in the United States. Foreign nationals were routinely collecting proceeds from a sale, and not reporting the income/profit generated by the sale of that property. Under FIRPTA, the Seller is obligated to pay 10% of the gross sales price to the Internal Revenue Service, unless the Seller can provide proof that either no taxes or a lesser amount is owed on the transfer. The Act further provides that if the 10% is not paid, or otherwise satisfactorily addressed by the seller, a lien for 10% of the sales price automatically attaches to the real property. As a result, a Buyer could be obligated to pay the IRS 10% of the gross sales price of the property.
Consider the following example. Patrick Irish, a citizen of Ireland, owns real property in Florida. Mr. Irish and Joe Buyer enter into a Purchase and Sale Agreement for a purchase price of $1,000,000. Mr. Buyer obtains a title search on the property, and determines that there are no recorded liens against the Seller. In an attempt to save closing costs, Mr. Irish and Mr. Buyer dispense with obtaining a title insurance policy, and independently prepare the Warranty Deed and conduct a closing without the services of legal counsel or a title insurance underwriter.
The format and execution of the deed conform with Florida law. The deed is recorded, and all documentary stamps and real estate property taxes are paid. Six months later, Joe Buyer receives a letter from the Internal Revenue Service assessing him $100,000 for the transfer from the Seller. Mr. Buyer of course now seeks legal counsel and asks “What is this letter about?” Due to FIRPTA, Mr. Buyer learns that he may now have to pay the IRS $100,000.
In a typical real estate closing, the Seller signs an Owner’s Affidavit that establishes, among other things, whether or not the Seller is a foreign individual as defined under FIRPTA. When the Seller is a foreign individual (which includes foreign corporations and other legal entities), it is standard practice for the closing agent to complete and submit the relevant FIRPTA forms, along with 10% of the gross sales price, to the IRS’ FIRPTA Unit–all within 20 days of closing.
The 10% tax must be submitted even if the settlement statement reflects that the Seller did not receive any money from the closing. If there are insufficient funds, the Seller must come “out of pocket” to pay this 10% obligation, or the closing cannot be completed. The Seller may reduce or eliminate that payment obligation by timely filing a withholding certificate with the IRS, which establishes that no taxes, or a reduced amount of taxes, are owed. Of course, none of this was done by Mr. Irish and, as a result, Joe now owes the IRS $100,000, or must otherwise justify to the IRS why that money is not owed. Joe can seek reimbursement from the Seller. Unfortunately, the outcome of that request is very predictable.
There currently exists one exemption under FIRPTA pertaining to the payment of this 10% obligation by the foreign Seller. This exemption applies when the gross sales price is under $300,000; the property is residential in use; and, the Buyer signs an affidavit stating that he (and his relatives) will live on the premises more than half of the number of days that the property is occupied by anyone for residential purposes during each of the two years following the purchase. Periods of time when the property is vacant are excluded from this calculation. In other words, you can’t rent or “loan” the property to non-family members for more than half the time the property is occupied during a given year.
Sometimes these affidavits are executed in a spirit of cooperation with the Seller, without the underlying requisite intent to reside on the property for the stated time periods. If the affidavit is proven to be fraudulent, the tax obligation will attach to the real property, together with any penalties for fraud. The Buyer will then be obligated to pay taxes he or she may not otherwise have been obligated to pay if he or she had not signed the affidavit. If there is any question as to the validity of the statements in this Buyer’s affidavit, the Buyer clearly should not execute the document.
In addition to the typical arms-length sale of property by a foreign Seller, there are other events which may trigger the application of this FIRPTA obligation.
For example, a foreign corporation may decide to distribute real property to one of its shareholders. Technically, no money is paid. However, the IRS may treat this as a taxable transfer. If 10% of the gross property value is not paid to the FIRPTA unit, the shareholder/transferee may not only be obligated to pay the transfer tax for the property conveyed from the corporation, but that same shareholder (if a foreign citizen) may also have to pay taxes a second time, when selling the property at a later date.
Whenever real property is being transferred to you by a foreign individual or entity, it’s wise to protect your financial interests by consulting with an attorney or CPA before proceeding with the conveyance. You should ascertain through legal counsel that the FIRPTA rules have been satisfied and that this potential hidden lien will not attach to the property being purchased.
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Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank has been involved in the Central Florida community for more than twenty-five years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980. Frank is a member of The Florida Bar, the California Bar, and the District of Columbia Court of Appeals. He is also admitted to the U.S. Supreme Court. He has served on the Orange County Bar Association Real Estate Committee and is a member of the The Florida Bar’s Real Property and Corporation and Business Law Section. He has also served on the Florida Bar Grievance Committee.
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