Is the Seller a “Foreign Person”? Buyers, FIRPTA Says You Better Find Out
Craig on 10 7, 2011
This is not legal advice. For legal advice, consult an attorney in person about your specific situation. Never rely on a blog.
The Foreign Investment in Real Property Tax Act (FIRPTA) is a federal law that requires a “foreign person” to pay tax on the gain realized upon the sale of real property owned by that person. However, the law does not charge the seller with insuring compliance. Rather, the law requires the buyer to determine whether or not the seller is a “foreign person” (basically a non-resident alien). If the seller is a “foreign person” as defined by the statute,then the buyer must withhold 10% of the sale proceeds at closing. These funds are to be forwarded to the IRS to insure that the foreign person pays tax on the gain realized from the transfer. If the buyer fails to determine that the seller is a foreign person and thus fails to withhold 10% of the proceeds, the buyer is liable for the 10%. WOW! That’s significant.
The NWMLS, recognizing the risk to buyers, has included a “FIRPTA” provision in the standard Purchase and Sale Agreement:
j. FIRPTA – Tax Withholding at Closing. The Closing Agent is instructed to prepare a certification (NWMLS Form 22E or equivalent) that Seller is not a “foreign person” within the meaning of the Foreign Investment In Real Property Tax Act.Seller shall sign this certification. If Seller is a foreign person, and this transaction is not otherwise exempt from FIRPTA, Closing Agent is instructed to withhold and pay the required amount to the Internal Revenue Service.
Sounds reasonable, right? Make the Closing Agent responsible for compliance. Escrow is not only the one in regular contact with the seller — and thus able to determine whether seller is a foreign person — but also the one holding the money and therefore easily able to withhold the 10%. And if escrow takes care of it, then the buyer doesn’t have to.
So what’s the problem? Check your escrow instructions that all parties sign at closing (if not prior). Escrow instructions supplement the “instructions” of the PSA. They further inform escrow what it iis and is not responsible for in closing the transaction. As you will probably see, the escrow instructions specificaly relieve escrow from any responsibility for insuring compliance with FIRPTA (in my experience this is common among the standard instructions issued by the various escrow companies in the area). Obviously, if the escrow instructions state that “escrow is not responsible for…” and if all parties agree to those instructions, then escrow is relieved of that responsibility.
Where does that leave the buyer? As attorneys say, significantly exposed to potentialy substantial liability. Or, in layperson’s terms: you may be royally screwed. We’re not talking about nickels and dimes here, as 10% of the purchase price will range from a big to a REALLY big number. And we’re not talking about liability to a third party that might be avoided or even discharged. Instead, you owe the IRS, and that’s tough to avoid. The Tax Man is tough to beat.
So if you’re a buyer, consider yourself forewarned. Don’t rely on escrow to determine whether the seller is a “foreign person” and whether you need to withhold 10% on behalf of the IRS — at least not without further followup and revision of the escrow instructions. Otherwise, you could find yourself liable to the IRS for 10% of the sale price…
About the Author: Craig Blackmon
- Author's website: http://blackmonholmes.com/
- More posts by Craig
- email the author
30 Responses to “Is the Seller a “Foreign Person”? Buyers, FIRPTA Says You Better Find Out”
Leave a Reply
Live Comment Preview
Popular Posts
Recent Posts
Recent Comments
- Johnny Brooks: That is a very commo
- Lyle Crews: This is a very inter
- Denise: I bought a house at
- Jan: It's $30 per company
- Neal: Is it $30 per *vendo
Craig,
This needs clarification.: “Don’t rely on escrow…” Buyers do not verify if the seller triggers FIRPTA. Never have. Let’s not alarm buyers needlessly. Your citation specifically says escrow to withhold funds in escrow, NOT the buyer.
-Tim
Legacy Escrow
Tim:
Duly noted, and I’ll draft a detailed comment clarifying my point. Unfortunately work beckons (darn needy clients!
) so I’ll have to address this weekend. But I’ll have that memo on your desk first thing Monday, Mr. Kane!
In the meantime, though, please tell me: What do your escrow instructions say about FIRPTA and your responsibility as escrow for compliance?
Craig
Per Mr. Kane’s request, clarification/further explanation:
The buyer of real property owned by a foreign person (or “transferee” as used in the statute) “shall be required to deduct and withhold a tax equal to 10%” of the sale price. 26 USC Sec 1445(a) If the buyer fails to do so, the buyer is “liable for such tax.” 26 USC Sec 1461 There are two exceptions that usually might apply. First, the buyer is relieved of this obligation if the seller provides to the buyer a statement signed under penalty of perjury stating (a) that the seller is not a foreign person and (b) the seller’s taxpayer identification number. 26 USC Sec 1445 (b)(2). Second, the buyer is relieved of this obligation if the sale price is not greater than $300k. 26 USC Sec 1445(b)(5).
You’re right, Tim, that buyers generally don’t comply with this requirement (I’m hesitant to say “never have” as that’s a pretty broad statement
). That is because the code allows for the buyer to rely upon the closing agent for obtaining the required statement (from seller that seller is not a foreign person). 26 USC Sec 1445(b)(9) and (f)(6). If escrow receives the required statement from the seller but knows the statement to be false, then escrow must promptly notify the buyer. 26 USC Sec 1445(d)(1). In that case, of course, buyer must withhold the 10%. But if escrow fails to so notify the buyer, then escrow is responsible for withholding the 10%, and if it fails to do so then escrow is liable for the tax. 26 USC Sec 1445(d)(2). Good news for you, though, Tim: Your liability is capped at the amount of compensation paid to you for closing the transaction. 26 USC Sec 1445(d)(2)(B). No such cap for the buyer, though…
Still don’t believe me? Check the Source of All Knowledge for another primer (one that, in my opinion, doesn’t sufficiently educate buyers as it notes only, “Penalties apply to a purchaser who fails to withhold, file Form 8288 with the IRS, or pay the required withholding within 20 days of the sale”).
So have I “alarmed buyers needlessly”? Gosh, if I’m wrong, then I sure have. But if I’m right, I think the “alarm” is totally justified. Perhaps I should have noted the “<$300k” exception initially, but on the other hand very few sales in this area qualify for that exemption. So for the vast majority of sales in the Seattle area, the buyer is legally responsible for determining that the seller is not a foreign person, and if not — if the seller IS a foreign person, then the buyer is responsible for withholding 10% of the sale price (or perhaps a lesser amount in some circumstances, 26 USC Sec 1445(c)).
At this point, Tim, I am officially calling you out: Is my analysis mistaken? If so, how so? If not, do you now agree that this is a big deal for buyers??
Finally, even if you don’t take the bait —
— don’t leave me hanging on my original question: What do the Escrow Instructions for Legacy Escrow say about your obligation to insure compliance with FIRPTA?
Look forward to continuing the discussion…
Thanks for the synopsis Craig and thanks for the “good news.” I’m feeling obliged to send you a SBUX coffee card for that free analysis with good information. Sometimes posts are a creation of something that came up transactionally that triggered the issue. Did something come up?
In other news: I will buy you dinner at Dick’s on Queen Anne or on 45th if you hold a workshop on this issue and anyone shows up, or, if they do, eyelids must be open for the entire workshop and necks cannot move past a 45 degree plane both anteriorly, laterally and posteriorly.
=)
I can’t point to a specific event — I’m NOT the “anecdotal contributor” here
— but at some point I realized in reviewing escrow instructions that escrow was relieving itself of any obligation to insure compliance with FIRPTA, notwithstanding the terms of the PSA. That in turn got me to look into FIRPTA in greater detail and — surprise! — it appears to be a significant issue that nobody appreciates. Or, hopefully at this point, nobody but RCG readers apreciate…
I’m always up for a meal at Dick’s, but typically that’s an end-of-the-night destination. Will you pick up the prior bar tab as well?
I’m amazed at the crickets I’m hearing in response to this post. I thought this was something of real interest and value, something unappreciated by most if not all… But maybe — just maybe — I didn’t hear anything because this is something that Ardell and David know nothing about…
In any event, I just came across this language in some escrow instructions, language that is very, very common in the instructions I see:
I think its safe to say, without a doubt, that I am NOT alarming buyers needlessly (in no small part because notwithstanding the first sentence of these instructions, this does NOT satisfy the requirements of the Act for excusing the buyer from the withholding requirement). Buyers, consider yourselves warned.
[...] few months ago I posted about the Foreign Investment in Real Property Tax Act (or FIRPTA, pronounced just like its spelled). I didn’t get nearly the response I imagined, [...]
Do you have examples of this being enforced?
Could it be one of those laws that do not get enforced, becuase of it’s inherent unfairness?
No, I am unaware of it being enforced — yet.
I’m not so sure the law is “inherently unfair.” What’s the unfair part? That foreigners don’t get the same tax breaks when selling real property? That somebody must be responsible for withholding some of the proceeds to insure that the tax gets paid? That the “somebody” is the same person who brings the money to the table and therefore is in the best position to withhold?
That said, I get your point. While it may not be “inherently unfair” to impose this obligation on the buyer, obviously escrow is in a much better position to make sure the law is satisfied (escrow also holds the proceeds, and unlike the buyer escrow has direct communications with the seller). But remember that there is one federal law and 50 states, each with their own laws and culture regarding the sale of property. Furthermore, there is no legal requirement for escrow and at least some private transactions “close” without using an escrow agent. But the one commonality between all states and all transactions: There is always a buyer. So I suspect that’s why the obligation falls on the buyer.
Finally, do YOU want to rely on the decision of the IRS to not pursue tax income because the law behind it is “unfair”? Good luck with that…
So I read the source at the IRS. It seems to have been put in place in 1980. Is that correct? And no known enforcement of it since then (that is forcing the buyer to pay the tax).
The code appears under the “Business” Heading, not the individual heading, though I admit there’s nothing I saw that excluded individuals.
As to the unfairness element…we’ll the seller had the capital gians, but did not pay them, so now the IRS goes after the buyer, who has had no capital gains.
Seems a bit like taking over a business from someone, discovering that individual did not pay his income taxe sand
Seems a bit like taking over a business from someone, discovering that the individual did not pay his income taxes, and the IRS coming after you for the arrears.
I doubt this will affect the average home buyer. I’ll get more interested if there are actual cases of enforcement against homebuyers.
Perfect! Until then, ignorance is bliss….
A reasonable plan, all things considered, but not one that I recommend as an attorney.
Ignorance is not blissful, but certainly hypervigilism against unlikely events is not blissful either.
I reviewed a few closed transactions, including lender instructions to escrow, and found no reference to FIRPA. I’ll check it out on the next one, and see what escrow says.
I suspect that IF a buyer were hit for this fee by the IRS (since you haven’t provided an example of it being enforced), a lawsuit against escrow and the seller would commence.
Not sure of the outcome, but generally the courts seem to think the professionals in the room should be providing adequate advice to the clients.
I guess that’s good for attorneys.
Just curious, why is this coming up if the law has been in place since 1980?
That’s a great point: “Hypervigilism” is not good either. And you’re right, any analysis of a legal issue must take into account the risk associated with not complying with the law. In this discussion we seem to be operating under the presumption that the IRS does not enforce this law.
Note that I think this presumption is grossly premature because it is based purely on my anecdotal knowledge. Since I am one attorney in a very large world, and since this issue also implicates tax law which I do not practice, I think this presumption is misplaced pending lots additional information. Nonetheless, for purposes of this discussion I will move forward on this presumption.
Thus, the risk of any adverse consequence of ignoring — whether intentionally or not — obligations under FIRPTA is very, very low. That said, even if the IRS has never enforced this law previously, it is the law and the IRS could at any point in the future choose to enforce it. Indeed, the point of my subsequent post is that, as more foreigners buy property in the US, the IRS has a greater incentive to enforce the law. If enforced, the consequences are significant: buyer is liable to the IRS for 10% of the sale price. Under these circumstances, we will have to agree to disagree whether this constitutes “hypervigilism.”
Other comments: You won’t find reference to FIRPTA in loan docs. Its not a lender issue. It is federal law applicable to the buyer. I thought you read the statute?
What does escrow say? See my comment above. Most large escrow companies — with the exception at least of Stewart Title, my new favorite escrow company — attempt to disavow their obligation imposed under the PSA to insure buyer compliance with FIRPTA. In a nutshell, they routinely tell buyer that it is buyer’s responsibility to insure complianced. Which is total BS because the buyer has zero contact with the seller thus making it virutally impossible for the buyer to, on his/her own, comply with FIRPTA.
Finally, you’re right the buyer might have a claim against escrow for tax liability incurred as a result of a failure to comply with FIRPTA. But that claim is far from clear cut again given the typical contents of escrow instructions. And besides, who wants to rely on a lawsuit to recover a significant tax liability when compliance avoids the issue entirely?
Well, a layperson reading a synopsis of a statute is nowhere near the same thing as an attorney reading a statute!
Thanks for the clarifications.
Your main point seems to be that escrow companies may be trying to avoid a responsibility imposed by the IRS. We agree there.
I guess the buyer could gum up the transaction by insisting the escrow company comply with the holdback (generally buyers do not select the escrow company, the sellers, or seller’s agent does). Wonder what would happen then? As a loan originator, I see blown locks and painful delays…
Interesting discussion, thanks for bringing it to light. I think I’ll go get some meteor protection now.
Good stuff, Roger — I appreciate the humor!
Not to get last word (although did you know I was a lawyer?) but really the buyer must first simply insure compliance with FIRPTA, i.e. get the required statement from seller noting they are not a “foreign person” and therefore there is no tax to withold. That is what every buyer should insist upon in dealing with escrow, exactly as spelled out in the Form 21. Now IF the seller really IS a foreign person, then at that point you’re right, it would be a serious problem to address. But better to identify it and if necessary address it rather than simply hoping it doesn’t exist — although we apparently disagree on that point given the likelihood of resulting harm.
Did not realize it would be so easy…if so, then it approaches the cost of taking vitamins…no idea if they really do any good, but they are cheap insurance (come to think of it, meteor insurance is probably pretty cheap too!).
So what if the seller is a foreign national, AND it is a short sale? Hoo-boy! The bank won’t likely approve the 10% hold back.
I’m used to how blogging comments work…it’s like you’re Rush Limbaugh, I never expect to get the last word. Not really my goal anyways.
I learn a lot in this manner, but learn more if I probe with clarifications.
Meteor Insurance, yeah, we need that.
Escrow does ask, they are required to ask for tax payer information.
No Real Estate agent is supposed to ask for the immigration status. What would that look like anyway? Oh, well you look like you’re from some place outside of the United States, before my buyer can proceed we’ll need to see your papers.
Absent escrow fulfilling its obligations under the PSA — but not under the contrary escrow instructions as quoted above — you’re left with just that, David: Is this seller possibly a “foreign person”? If so, then the buyer is doubly foolish to not seek compliance with FIRPTA. But of course, it is essentially impossible for the buyer to comply by himself since he never sees or interacts with the seller and certainly never has an opportunity to present the “FIRPTA form” for completion and signature. So you’re left with wrestling with escrow — at least those that seek to avoid any obligaion for FIRPTA compliance, which DOES NOT include Stewart Escrow — to get them to insure compliance.
Or not. You can always take Roger’s route and simply hope for the best: The IRS won’t track down unpaid taxes, and you won’t get hit by a meteor. Frankly, I think the former is MUCH less likely, but everyone has their own risk tolerance.
Craig:
As a member of the media, you have a position of responsibility. Yes, a blogger on RCG is a but minor member of the media, but still…, I often see better in depth reporting here than the MSM. Perhaps you have your lawyer hat on more, that is, your job is to present every legal risk, without the additional analysis of the importance of those risks.
As a journalist, it is not enough to point out a potentially calamitous danger (it’s too easy, and self serving); you should also present the liklihood of such a calamity occuring, otherwise you are only fearmonging. Just a tad more research is required..
How many instances have there been of enforcement against buyers of residential properties valued between $300K and $2M in the past 30 years? I’d exlude commercial properties because those buyers should haver legal representation anyways, and properties over $2M because of their rarity.
Now that would be a useful addition to the story, allowing the buyer in that range to assess the risks appropriately.
Roger, I thought we resolved this issue above and agreed to disagree. Nonetheless…
First, there is value in knowing the law and one’s legal obligations. While its apparent this does not apply to you, there are some people who genuinely want to abide by their legal obligations, regardless of whether they’ll get caught, or if caught the liability that might result. In other words, some people DON’T start by asking, “Will I be caught?” when determining whether to comply with their legal duties. I would think even someone like you, who apparently cares little about the law where the likelihood of being caught is extremely low, would still be able to appreciate that point. It takes all types, Roger, and thankfully many of those types honor and respect the law and their legal obligations, regardless of the likelihood of getting caught. This isn’t Greece…
Second, I humbly submit that your “Will I get caught?” analysis is only marginally relevant when analyzing income tax liability to the federal government. We’re talking about the Tax Man here, who is not known for gladly letting people avoid their payment obligations. Just the opposite in fact: The IRS, once its on you, is very, very difficult to shake, and your liability can be very significant (and undischargable via bankruptcy). Accordingly, in terms of tax obligations, the “Will I get caught?” analysis is of less value than in other settings (like whether to build a shed within a legally required setback).
Third, I’m not even sure how to go about getting the data you request. I guess I could go to the IRS website and use their “Instances of Enforcement” search engine to get answers to your question using the parameters you set forth above. You know the site I’m talking about, the one where any taxpayer can find out when, how often, and under what circumstances IRS tax laws are enforced…
I stand by my post, Roger. If you want to argue that buyers don’t need to worry about FIRPTA because its rarely enforced, knock yourself out. And good luck with the research necessary to support your position.
Odd, I didn’t think my response was hostile, or merited a hostile response (stating that I “care little about the law, unless I get caught” seems a bit personal). But perhaps I gave offense, where none was intended. I thought of it as a resonable request for more information from someone knowledgable in the field.
Admittedly, finding such information may be difficult and provide no cost benefit for either of us, so perhaps it is not reasonable. I incorrectly thought you might be interested in the question, sort of like a scholarly inquiry.
Of course there is value in knowing the law. IMO, we live in an overly legalistic society, that would be better served by taking a bit more consideration for each other, rather than reaching for the legal club at first imagined offense.
But that’s just me, and it’s not the subject of this post. The subject is that such a law exists, (possibly in a sort of vacuum, since no one I’ve asked about it has any knowledge of it); this is not in dispute.
We can and do respectfully agree to disagree as to it’s relevance, and I gladly defer to your greater knowledge of the law. And BTW, I do pay my taxes…, probably too much, since I do them myself.
It’s a discussion? and worthy of a second post on the same subject?
I’ve had it come up on more than a couple off occasions, as both a buyer’s agent, and listing agent. As a listing agent I have had escrow ask me point blank if these people are foreign nationals. It is legal for foreign nationals to own Real Estate. Yes the taxes are due.
It is kind of a routine question when you work in circles where you have many foreigners. The Asian community in particular, and Hispanic community to a lesser extent.
I have asked if the seller had the right to sell the property, for a variety of reasons, but this is because of the work I do in minority communities.
Other than that you are for sure interjecting a concern where none exists.
And, apparently, worthy of two comments from you!
Yes, David, absent my post about tax law there would be no concern whatsoever. Apparenlty you’re also an adherent of the “Ignorance is Bliss” school of thought….
You got the second comment out of me because Tim reposted a link to this article.
There is a clause j that instructs escrow to prepare the FIRPTA form 22E.
It’s in all Purchase and Sale Agreements. Now your concern is that some agents wouldn’t follow through with that requirement, I guess.
What’s bothering me is that you found a clause you didn’t understand, and researched it.
You’re a Broker, who owns a Real Estate company, and you just now getting around to understanding the forms.
It’s a standard clause that has been there for decades if I remember correctly.
Three comments, and counting! Although this is my last reply for reasons that I can hopefully make obvious.
Yes, I am very familiar with Paragraph j of the Form 21 PSA, as is every reader of this post. If you take the time to look above, at the original post, you will see Paragraph j quoted in full. It’s the big grey box in the middle of the post. Go ahead, read the post and you’ll likely catch it.
My concern is NOT that “some agents” won’t follow through with this requirement. Rather, as explained in detail in the post and most of the comments above, the concern is that escrow typically seeks to avoid its obligation to comply with the terms of Paragraph j. You can tell this post is about escrow shirking its duty, thus creating significant exposure for the buyer, by my repeated use of terms like “closing agent” and “escrow” and even my exchange with Tim Kane, who as you know runs an escrow business.
Finally, I am NOT “just now getting around to understanding the forms.” First of all, and again, this isn’t about “the forms,” its about the legal obligation imposed on a buyer by federal law and escrow’s usual attempt to avoid any responsibility for insuring compliance notwithstanding the terms of the PSA. Its about the serious potential legal liability to the buyer that results. Its about educating buyers to this fact.
Oh, and FYI, FIRPTA was enacted in 1980 so Paragraph j is certainly not any older than that.
Got a fourth comment in ya’ for this superfluous post??
Absolutely, because it is frivolous. It has been there since 1980. So why your concern now?
As far as escrow, yes, an agent needs to check the work escrow does; Welcome to Real Estate!
Yes I read the post in 2011, and have been working from memory, you got me!!!! However your continued attacks are always a concern.
It bothers me when brokers attack the Real Estate industry.
I thought of a better question of why don’t you, Ray Pepper, and Glenn Kelman get together to compare notes on all the things wrong with the Real Estate business, and present those to the NWMLS.
The outlet for your concerns should be the NWMLS, rather than a blog post. You’re a Broker who owns a Real Estate company.
David, please don’t take this personally, but you seem to have some serious difficulty in following and understanding an author’s point.
In this instance, this post is NOT about the NWMLS or the broker system. Indeed, it has NOTHING TO DO with these topics. The post is about a federal law that imposes obligations on buyers, obligations that are not understood or even recognized by the vast majority of buyers. Moreover, the form contract instructs escrow to insure that a buyer complies with these obligations, but escrow companies routinely relieve themselves of this obligation in their instructions. Accordingly, the vast majority of buyers have substantial exposure to an adverse IRS liability that, if imposed, will result in a tax penalty of tens of thousands of dollars. Its not about brokers or the NWMLS, its about federal law and the obligations imposed on, and because of escrow’s actions frequently not satisfied by, buyers. But you apparently are incapable of understanding that point.
Putting aside the fact that you’ve missed the point entirely — and now repeatedly — I’ll respond, notwithstanding the fact that this discussion has nothing to do with the post:
Huh? Because I own and operate a real estate firm, I cannot voice my concerns with the industry? I cannot work to change the industry for the better? Per your view, I must sit silently, muzzled and in the corner, without a peep as to how to make things better, even though as a lawyer (who has a better understanding of the practice of law, in which brokers engage all the time) and as a fellow broker I have relevant insight and knowledge. With all due respect, we’ll have to agree to disagree on that point….
P.s. I said you’d get last word, but you piled on with TWO comments! Play fair, David, would ya’?
Playing fair is knowing how our system works, and working with the system. If you have a concern with this, you, as a Broker, and owner of a Real Estate company, can take that concern to the NWMLS to get them on board to change the forms to your liking, as an attorney.
“Accordingly, the vast majority of buyers have substantial exposure to an adverse IRS liability that, if imposed, will result in a tax penalty of tens of thousands of dollars.”
Vast majority? Where do you get this?
and then you follow it up with “I’ll respond, notwithstanding the fact that this discussion has nothing to do with the post:”
This is your post. You are making claims to the public about a slight of contract that, you, as an attorney, I guess, have “discovered.”
It’s been in the contract since 1980, I’ve dealt with it successfully on more than a couple of occasions, and according to you, I’m not the sharpest tool in the shed.
So there is a place to raise these concerns, for you as a Broker, and that place is the NWMLS, that has meetings you are invited to.
What is so hard to follow about that?