FIRPTA Definitions of Terms and Procedures
The following terms have special meanings with respect to FIRPTA Definitions.
The disposition of a U.S. real property interest by a foreign person (the transferor) is subject to income tax withholding. The transferee is the withholding agent. If you are the transferee, it is your obligation to find out if the transferor is a foreign person. If they transferor is a foreign person and you fail to withhold, you may be held liable for the tax.
Many transactions qualify as dispositions, including but not limited to the sale/purchase or real estate, gifts, redemptions, and capital contributions.
Withholding is required on certain distributions and other transactions by domestic or foreign corporations, partnerships, trusts, and estates.
A foreign corporation that distributes a U.S. real property interest must withhold a tax equal to 35% of the gain it recognizes on the distribution to its shareholders. However, this withholding requirement does not apply if the foreign corporation has elected under IRC section 897(i) to be treated as a domestic corporation.
A domestic corporation must withhold a tax equal to 10% of the fair market value of the property distributed to a foreign person if:
- The shareholder’s interest in the corporation is a U.S. real property interest; and
- The property distributed is either in redemption of stock or in liquidation of the corporation.
U.S. Real Property Holding Corporation (USRPHC). In general, a corporation is a U.S. real property holding corporation if the fair market value of the U.S. real property interests held by the corporation or any applicable determination dates equals or exceeds 50% of the sum of the fair market value of its:
- U.S. real property interests;
- Interests in real property located outside the United States; and
- Certain business assets.
A distribution form a domestic corporation that is a U.S. real property holding corporation is generally subject to NRA withholding and withholding under the U.S. real property interest provisions.
This also applies to a corporation that was a USRPHC at any time during the shorter of the period during which the U.S. real property interest was held, or the 5-year period ending on the date of disposition. A USRPHC can satisfy both withholding provisions if it withholds under one of the following procedures.
- Apply NRA Withholding on Forms 1042/1042-S on the full amount of the distribution, whether or not any portion of the distribution represents a return of basis or capital gain. If a reduced tax rate applies under an income tax treaty, then the rate of withholding must not be less than 10%, unless the treaty specifies a lower rate for distributions from a USRPHC.
- Apply NRA Withholding on Forms 1042/1042-S to the portion of the distribution that the USRPHC estimates is a dividend. Then, withhold 10% on the remainder of the distribution (or on a smaller amount if a withholding certificate is obtained and the amount of the distribution that is a return of capital is established).
While the same procedure must be used for all distributions made during the year, a different procedure may be used each year.
If a domestic partnership that is not publicly traded disposes of a U.S. real property interest at a gain, the gain is treated as effectively connected income and would not be subject to withholding under the FIRPTA provisions.
A publicly traded partnership that disposes of a U.S. real property interest must withhold tax on distributions to foreign partners, unless it elects to withhold based on effectively connected taxable income allocable to foreign partners.
Trust and Estates
Trustees, fiduciaries, and executors of a trust or estate having one or more foreign beneficiaries are withholding agents. Such withholding agents must establish a U.S. real property interest account, and enter into it all gains and losses realized during the taxable year of the trust or estate from dispositions of U.S. real property interests. Withholding agents must withhold 35% of any distribution to a foreign beneficiary that is attributable to the balance in the real property interest account on the day of the distribution. A distribution from a trust or estate to a beneficiary (foreign or domestic) will be treated as attributable first to any balance in the U.S. real property interest account and then to other amounts.
A trust with more than 100 beneficiaries may elect to withhold from each distribution 35% of the amount attributable to the foreign beneficiary’s proportionate share of the current balance of the trust’s real property interest account. This election does not apply to publicly traded trusts or real estate investment trusts (REITs). For more information about this election, refer to section 1.1445-5(c) of the regulations.
Publicly traded trusts and REITs must withhold on distributions of U.S. real property interests to foreign persons. The withholding rate is 35%. For more information, including how to compute the amount subject to withholding, refer to section 1.1445-8 of the regulations.
Generally, any distribution from a qualified investment entity attributable to gain from the sale or exchange of a U.S. real property interest is treated as such gain by the nonresident alien individual or foreign corporation receiving the distribution. For tax years beginning after October 22, 2004, any distribution by a REIT on stock regularly traded on a securities market in the United States is not treated as gain from the sale or exchange of a U. S. real property interest if the shareholder did not own more than 5% of that stock at any time during the REIT’s tax year. These distributions are included in the shareholder’s gross income as a dividend from the REIT, not as long-term capital gain.
U.S. Real Property Interest
A “U.S. real property interest” includes actual property (such as land), improvements on property, personal property items, and undeveloped natural resources. This term also encompasses assets that are less commonly through of as property, such as shares in stock; interest in a corporation; interest in a partnership; and any other ownership rights to a U.S. business or real estate.
A “foreign person” is a nonresident alien individual, foreign corporation that has not made an election under Section 897(i) of the Internal Revenue Code, foreign partnership, foreign trust, or foreign estate.
The term “foreign person” does not include a resident alien individual.
The term “transferor” means any foreign person that disposes of a U.S. real property interest by sale, exchange, gift, or any other transfer. A transfer includes distributions to shareholders of a corporation, partners of a partnership and beneficiaries of a trust or estate.
The owner of a disregarded entity is treated as the transferor of the property, not the entity.
The term “transferee” means any person, foreign or domestic, that acquires a U.S. real property interest by purchase, exchange, gift, or other method of transfer.
The “amount realized” by the transferor is the sum of:
- The cash paid, or to be paid (principal only)
- The fair market value of other property transferred, or to be transferred; and
- The amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.