Is the Seller a “Foreign Person”? Buyers, FIRPTA Says You Better Find Out

ID-10075952This is not legal advice. For legal advice, consult an attorney in person about your specific situation. Never rely on a blog. [Updated 12/17/14]

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 make the seller responsible for paying this tax.  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. If you just bought a $400,000 house from a foreigner and did not satisfy your obligations under this statute, you may be liable to the IRS for a cool 40 grand. Ouch.

The NWMLS, recognizing the serious risk to buyers, has included a “FIRPTA” provision in the standard Purchase and Sale Agreement (PSA):

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.

So that’s good news! The PSA specifically instructs the closing agent, aka escrow, to make sure the buyer complies with this legal obligation.  Whew!

Wait, there’s bad news? Yep. Virtually every escrow company has its own “escrow instructions” that elaborate on the terms of the PSA.  And guess what?  Those instructions relieve the escrow agent from taking any steps to make sure the buyer complies with FIRPTA.  Here is the language from some commonly used escrow instructions:

Seller warrants to Escrowee [i.e., the Closing Agent] that if Seller is an individual, Seller is a non-resident alien for purposes of U.S. Income taxation, or if Seller is a corporation, partnership, trust or estate, Seller is not a foreign entity. The Foreign Investment in Real Property Tax Act of 1980 as amended by the Tax Reform Act of 1984 places special requirements for tax reporting and withholding on the parties to a real estate transaction where the transferor (seller) is a non-resident alien or non-domestic corporation or partnership or partnerships. It is understood and acknowledged by the undersigned that (a) Escrowee will not take an active role in either the determination of the non-alien status of the seller transferor or the withholding of any funds; and (b) Escrowee makes no representations and (c) Buyer and Seller are seeking an attorney’s, accountant’s, or other tax specialists opinion concerning the effect of this Act on this transaction and are not acting on the statements made or omitted by the Escrowee.

So what protection the PSA provides, the escrow instructions take away. “Whew!” is grossly premature.

Obviously, “consulting with an attorney or other specialist” is simply the escrow company engaging in a little CYA.  The closing agent, and only the closing agent, is in a position to obtain the necessary signed certification. The PSA instructs the closing agent to do so.  But the closing agent promptly tells the buyer that it will not do so. If you’re a buyer in this situation, watch out. You could get some exceptionally bad news from the IRS long after you’ve purchased the home.

Not convinced? Check out my follow-up post where I flesh out my opinion with those of several other residential real estate lawyers.

Finally, this is a fantastic illustration of how a buyer can benefit from having an attorney on board from the get-go. At Quill Realty, we provide every client with an attorney (and we pay the attorney’s fee). So if you’re a Quill client, you can rest assured that your attorney will identify and resolve this issue (usually by demanding that the closing agent comply with the terms of the PSA and not those of the escrow instructions, to which they usually agree).  Not a Quill client?  Well, good luck in seeking to eliminate this very substantial post-closing exposure to the IRS…

The First Time Home Buyer Tax Credit Advance May NOT Be Used Towards the 3.5% Down Payment…UNLESS…

Update 6/10/2009 11:20 am:  Please read the comments 1-21 (especially Aubrey Cohen’s comments).   Apparently according to a HUD representative, the tax credit can be used for down payment if it’s received through State Housing Finance Agencies.   (I called the FHA help line twice this morning and both FHA representatives say this is not the case).  The representative from HUD apologizes for the confusion and will make sure the Homeownership Centers understand… I apologize for the confusion too!

I feel like shouting “THE TAX CREDIT ADVANCE IS NOT DOWN PAYMENT ASSISTANCE!” up and down the streets of Seattle.  Home buyers utilizing FHA loans still need to come up with a minimum of 3.5% for their downpayment (see the update above).   Per HUD’s Mortgagee Letter 2009-15 dated May 29, 2009:

“The proceeds of the sale of the tax credit to FHA approved mortgagees, the seller, or any other person or entity tha tis reimbursed, directly or indirectly…may not be used to meet the 3.5% minimum down payment, but may be used as additional downpayment, buying down the interest rate, or other closing costs.”

Jane and John are buying a home using FHA for financing with a sales price of $300,000.   FHA requires they invest a minimum of 3.5% of the sales price into the transaction.   Jane and John need to have $10,500 of their own funds (which can be gifted or loaned from a family member) invested into this transaction.   Assuming they qualify for the First Time Home Buyer Tax Credit and the IRS figures out how to resolve the issues of how to pay the FTHB Tax Credit Advances, they could use the $8000 towards closing costs, prepaids and any extra funds (after paying closing costs and prepaids AND after they invest $10,500) could go towards downpayment.  (Unless…see the update above).

This is not a zero down program and this is not like the ol’ DPAs (Nehemiah, etc.).   This is (if the details are ever worked out in time) an advance or loan against your tax credit.

Haaa… I feel a little better now.  🙂  One of the benefits of blogging… venting!


The snow is[photopress:snow_picture.jpg,thumb,alignright] finally melting off the tree branches in my yard today. One foot of snow fell last Wednesday afternoon turning my normal 45 min commute to Issaquah into 4 hours. I’m really impressed with how well the agents are doing maneuver on these slick streets. I had a showing Friday night, Saturday and Sunday on one listing, even though the roads are still slick and hard to navigate out here in Issaquah.

Nice to be back to RCG. I’ve been buried in an investment class for the last 3-4 months and haven’t been keeping up with the post reading or writing. Came up for breath today and I see that a Welcome to all the new contributors is in order! We’re honored to have you on board. 

Given that it’s tax time, I want to remind everyone to be sure you’re aware of all the tax advantaged investment programs out there for real estate. Who knows how long these will last. There’s a great new program called a solo 401K to go along with the Roth IRA programs investing in real estate.  I’ve blogged about this before and hope you check it out especially if you’re paying taxes on any real estate gains this year. 

I’m building a good retirment by investing this way and it will all be tax free.  A key player in the IRA game is the custodian.  I’ve been waiting for the new custodian in Seattle, Viking Bank with Jim Winder in charge of the Self Directed IRA department to get their website up and running so that RCG readers can get information on line. Jim Winder is a well known guru of self-directed IRA’s and he is respected local celebrity and has taught many many classes in the past.  He promises the Viking Bank site will be functional soon.  But it is tax time so until then, I’ll direct you to Pensco Trust to learn all you need to know about some really great tax strategies using some of the money you’ve already socked in retirement plans. Pensco Trust is a national leader in IRA education so I hope you find these articles helpful.  

Once Jim’s fully in the game I’ll post you his site and when he’ll be teaching live classes.  LTD will be hosting one, soon, I hope, and by the way, I met Jim here on RCG!

The Tax Man Cometh and Stayed and Stayed

I hated to be so absent on RCG the last couple of weeks, (took me several hours to catch up on posts. Ardell, you’ve outdone yourself, as usual, plus all those deals!Dont’ know how you do it). Here’s my excuse, I’ve had two audits this spring and they’ve both buried me. Plus I’ve been on two investment fact finding trips and hired two new agents for LTD just this week. (hmm, something about 2’s) I’ve been buried but wanted to share something that I thought my 2 (there it is again) tax attorneys and one real estate attorney should have prepared me for and had never heard of.

You try to listen to your attorney when he or she tells you to protect yourself and set up an LLC. but, if you’re like me and didn’t give much thought to how you share staff, leases, assets like office furniture, holdings, like real estate holdings, etc, etc, etc, please avoid the following that can cost thousands if found in an audit.

[photopress:taxman_1_2_3_4_5.JPG,full,alignright]For example, if I own two companies, a construction company and a company that buys property, subdivides, remodels, build new, etc., and if an employee from the construction company (where the liabiltiy and stop gap insurance is) builds for the venture company, then I must charge sales tax to myself!. Yes, I know the LLC’s and the Inc.s are their own entities, but it never occurred to me that I’d have to charge myself sales tax and give it to the state even if I’ve already paid sales tax at the point of sale. Similarly, if I bring my computer from home (or office furniture or ANYTHING and GIVE it to one of my companies, I must again pay sales tax. I own the computer, I own the company, I paid sales tax when I bought the computer. However, the state wants it’s $ so they consider that I sold the computer and therefore must pay sales tax.

Another example. If the construction company pays an architect for plans for the venture company, then I must charge tax and pay it to the state, even though architects are a service industry and don’t incur sales tax. I could elaborate but it’s just more of the same. Reminds me of my restaurants I had in the 80’s. I had a similar audit and because I gave free meals to my employees(100 of them at $2/day for 5 years), I had to pay sales tax to the state on those FREE meals. Go Figure.

So, I’m now much poorer and hope I’ve alerted at least someone out there to watch this on your books. I have 11 LLC’s, I’m just glad the audit is done and I won’t get in trouble next time. There is the possiblility that there will be some relief for this injustice in July, but it would probably only affect some of the issues.

But, lesson learned and I’m now cutting paychecks out of 4 different companies. Four sets of W-2’s, etc for each employee. Yuck

I’m going to start blogging on some cool strategies to invest 401K, Seps, IRA, Roth IRA in real estate when I get the time, but I wanted to alert you to a webinar that is excellent being given by a great custodial company, Pensco, in case you want to hear how to invest one of those entities in real estate and use leverage, even though most accountants will tell you you can’t. There will be many upcoming webinars about similar subjects. Click here for a description and to register.

And on a better note, sold a 1.3 million piece of waterfront land on Beach Dr.near Alki today. Gotta pay for those taxes somehow!