FIRPTA implications

 

The Foreign Investment in U.S. Real Property Tax Act of 1980 (FIRPTA) was enacted to ensure that foreign investors are taxed on the gains from the disposition of their U.S. real property investment.58
Under the FIRPTA regime, a person purchasing U.S. real property interests (the “transferee”) from foreign persons, must withhold 10% of the amount realized (i.e., the entire purchase price, not just the gain).59

(Broker comment: The PATH Act of 2015 set into motion several tax extenders and new tax laws.  One area addresses Section 324 of the act increasing the rate of FIRPTA withholding from 10% to 15%.)

This is to differentiate from ownership through a foreign corporation, which requires a withholding of 35%60 (which is yet an additional factor making ownership through a foreign corporation less attractive).
In such a transaction, the transferee/ buyer is considered the withholding agent and has the responsibility to determine whether the transferor is a foreign person; otherwise, if the transferor is a foreign person and the appropriate amount is not withheld, the transferee/buyer may be held liable for the tax.61

For cases in which a U.S. business entity, such as a corporation or partnership, disposes of a U.S. real property interest, the business entity itself is the withholding agent.62
For this reason, many foreign investors use a domestic partnership63 to hold the US. real property interest.
Recall that an interest in a domestic partnership may be deemed as U.S situs property and may be included in the foreign investor’s U.S. gross estate.
To address this concern, the foreign investor may consider utilizing the so-called "two-tier partnership structure," under which the U.S. real property is owned by a US. partnership (the lower tier), which is in turn owned by a foreign partnership (the upper tier), which is owned by the foreign investor.64

Under FIRPTA rules, rental income is addressed differently.
Treatment of rental income depends on whether it is FDAP income or income effectively connected with a U.S. trade or business.
This determination for FIRPTA purposes is made in the manner discussed earlier in this article.
If the income is deemed FDAP income, it is subject to FIRPTA withholding rules on gross income.65
If the income is determined to be effectively connected with a U.S. trade or business, it will be subject to the ordinary income tax rules on a net basis.66