The U.S. real estate market continues to attract investors from around the globe. However, when a foreign individual or entity sells property located in the United States, a special tax regime applies: the Foreign Investment in Real Property Tax Act (FIRPTA).
FIRPTA is often misunderstood as an additional tax. In reality, it is a compliance mechanism designed to ensure that foreign sellers pay the tax legally owed on the gain from selling U.S. real property interests. Because non-U.S. taxpayers can easily move sale proceeds outside the country without filing a tax return, the U.S. Congress imposed a mandatory withholding requirement to protect the IRS’s ability to collect the correct tax.
This article explains why FIRPTA was enacted, how the 15% withholding works, what exceptions may apply, the buyer’s legal liability, and how foreign sellers should prepare for a smooth transaction.
What Is FIRPTA and Why Was It Enacted?
FIRPTA is a federal statutory framework ensuring that foreign individuals and entities pay tax on gains realized from the sale of U.S. real property interests. Because non-resident sellers are not subject to the IRS’s regular enforcement mechanisms, Congress introduced FIRPTA to safeguard tax collection.
Primary Purposes of FIRPTA:
✔ Guarantee the IRS’s ability to collect tax from non-resident sellers.
✔ Prevent foreign sellers from moving funds abroad without satisfying their tax obligations.
✔ Create an effective compliance tool where traditional enforcement is difficult or impractical.
FIRPTA achieves this through a mandatory withholding at the time of closing.
How the 15% Withholding Requirement Works
The hallmark of FIRPTA is that the withholding falls on the buyer, not the foreign seller. This guarantees that before any funds leave the U.S., a portion is remitted to the IRS to cover potential tax liabilities.
The general rule is that the buyer must withhold 15% of the gross sales price and remit it to the IRS using Forms 8288 and 8288-A.
Practical Example : Standard FIRPTA Withholding
A foreign seller sells property for $400,000.
Required withholding:$400,000 × 15% = $60,000
This amount is submitted to the IRS. The seller may later file a U.S. tax return to report the actual gain and request a refund if the withholding exceeds the tax owed.
Statutory Exceptions and Reduction Mechanisms
While FIRPTA applies broadly, several important exceptions and opportunities for reduced withholding may apply:
1. Residential Use Exception Under $300,000: If the buyer intends to use the property as a personal residence and the purchase price does not exceed $300,000, no FIRPTA withholding is required.
Practical Example :
A family purchases a home for $280,000 and plans to live in it as their primary residence.
No withholding applies.
2. Seller Is a U.S. Citizen or Resident for Tax Purposes: If the seller provides valid documentation proving U.S. citizenship or U.S. tax residency (e.g., a Green Card), FIRPTA does not apply.
3. Application for Reduced Withholding (IRS Form 8288-B): A foreign seller may apply for a reduced or exempt withholding certificate by filing Form 8288-B before closing. This allows withholding to reflect the actual estimated tax liability instead of the default 15%.
Practical Example:
A foreign seller’s actual gain is only $10,000, but FIRPTA withholding would require $60,000.
By filing Form 8288-B on time, the seller may reduce the withholding to an amount aligned with the actual tax.
Legal Liability of the Buyer and Closing Agents
FIRPTA’s enforcement mechanism is strict: if the buyer fails to withhold and remit the correct amount, the IRS may hold the buyer personally liable, including interest and penalties.
To avoid this, closing attorneys, escrow agents, and title companies typically oversee the FIRPTA withholding process.
Practical Example: Buyer Liability Exposure
A buyer purchases property for $500,000 from a foreign seller but fails to withhold.
The IRS can pursue the buyer for $75,000 (15% of the sale price), plus penalties and interest.
How Foreign Sellers Should Prepare for a FIRPTA Transaction
Effective preparation can prevent delays and reduce unnecessary withholding. Foreign sellers should:
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- Determine whether the transaction is subject to FIRPTA.
- Estimate the actual capital gain and projected tax liability.
- File Form 8288-B in advance if seeking reduced withholding.
- Consult an experienced tax attorney or advisor familiar with cross-border real estate transactions.
Understanding FIRPTA is crucial not only for foreign investors but also for U.S. buyers and real estate professionals involved in cross-border transactions.
For foreign sellers, proper planning can eliminate excessive withholding. Filing the correct forms leads to smoother closings, faster refunds, and avoids exposure to penalties or future disputes with the IRS.
For buyers, there is a significant financial risk if FIRPTA is ignored. Proper withholding protects the buyer from IRS enforcement and understanding the exceptions may allow more efficient transaction structuring.
For real estate professionals and closing agents, FIRPTA affects the closing process directly. Compliance and knowledge of FIRPTA rules ensures timely closings, enhances professional reliability, and reduces liability.
FIRPTA as a Compliance Tool, Not a Penalty
Although FIRPTA is often perceived as an additional tax burden, it is, in fact, a federal enforcement mechanism ensuring that foreign sellers pay the taxes legally owed on U.S. real estate transactions. With proper planning, timely filings, and knowledgeable legal guidance, both buyers and foreign sellers can navigate the process efficiently and avoid unnecessary withholding or legal complications.
