FIRTPA is the acronym of Foreign Investment in Real Property Tax Act. Purpose of the act is to address the concern that it would be extremely difficult, if not impossible, to collect income tax from a taxpayer who resides abroad especially if – after the sale – he or she does not own real estate property in the United States anymore.
Who is subject to FIRPTA?
The seller of real estate property in the United States is a subject to FIRPTA when he is not a US person but a foreign person for tax purposes. The buyer can rely on the affidavit provided by the seller to determine what is the seller’s status, unless the seller has reason to believe that the affidavit is false. A foreign person is a nonresident alien individual, a foreign corporation not treated as a domestic corporation, or a foreign partnership, trust, or estate. Each of those categories need to be examined separately:
A seller who is a US citizen or a US permanent resident/green card holder is exempt from FIRPTA withholding.
If the seller does not have US citizenship or a green card, he can still be considered a US person for tax purposes if he passes the substantial presence test, which consider whether the individual has spent sufficient time in the United States to make him subject to taxation. But how does the substantial presence test work?
The substantial presence test is met when the individual has been in the United States:
- For at least 31 days during the current year (so that the individual cannot pass the test for the current year if applied in January); and
- For at least 183 days in the year period that include the year being tested (the current year, if it is the one being tested) and the two years before the year being tested. The days should be pondered as follow:
- The total amount of days of the year being tested;
- 1/3 of the days of presence for the year before the year being tested; and
- 1/6 of the days of presence for the year before the year being tested.
Finally, the substantial presence test has its own exceptions. For example, if the person is present in the United States under a F Visa (student visa) he or she will be considered non-US persons for tax purposes and so subject to FIRTPA.
US entities are not subject to FIRTPA. Once again, it will be necessary to determine who is considered to be a US entity.
- Corporations incorporated in the United States or proving that they elected to be taxed as a domestic corporation under I.R.S. § 897(i) are US persons for tax purposes. Exception: a US corporation that is not publicly traded and has more than the 50% of its assets in real estate interests (a real estate holding entity) is considered a foreign entity.
- Partnerships organized in the United States, which are always multi-members, are US persons for tax purposes; the withholding will not affect the sale of the real estate interest, but the taxable income of the partnership.
- Limited Liability Companies do not exist for tax purposes: if single-member, a limited liability company is transparent and so considered as an individual for tax purposes; if multi-member, a limited liability company is a fiscal entity taxed as a partnership. However, limited liability companies can elect to be treated as corporations for tax purposes.
To be considered as a US person for FIRTPA purposes, a trust needs to pass a two prong test:
- The “court test”: whether a court within the US can exercise primary supervision over the administration of the trust, which is determined by where the administration is located and by whether a US court would be heard in case of dispute over the administration of the trust.
- The “control test”: whether the trustees qualifying as US persons have the authority to control all substantial decisions of the trust, and are in no way subject to the decisions of trustees who are not US persons.