Solving the Tax Mysteries of Real Estate Closings with a Foreigner

With the global economy of today, many real estate closings involve buyers and sellers who are foreign. A common thread to all real estate closings, whether a foreigner is involved or not, is that the IRS taxes the income generated by the sale of U.S. real property interests. To accomplish such taxing goal, the IRS requires the buyer to remit 10% of the gross purchase price if the seller is a foreigner. The buyer is typically assisted by the title agent when remitting the 10%.

Once remitted, the foreigner must wait to apply for a refund by filing a form 1040-NR (“non-resident”), just like an individual files a Form 1040, by April 15 of the year following the transaction. Oftentimes the Seller does not want to wait (or cannot wait) that long to obtain a refund. For example, the foreigner would not be able to wait for the refund if they want to reinvest the 10% in another piece of property and qualify for a 1031 Exchange (see Farr Newsletter January 2004 and February 2006).

The 10% withholding may be reduced or eliminated all together, depending upon whether there is a treaty enacted with the foreigner seller’s country which is designed to alleviate the burden of double taxation. To determine whether the withholding can be reduced or eliminated, the foreigner must complete and file an Application for Withholding Certificate (Form 8288-B) prior to closing. If the IRS processes and issues a determination letter on the application prior to closing, then the buyer does not need to withhold the 10%.

If the IRS does not process the Application for Withholding Certificate prior to closing, but the foreign seller presents a copy of a completed and filed Application for Withholding Certificate, then the buyer does not remit the 10% to the IRS, but instead the closing agent holds the 10% in escrow pending the IRS’s determination letter. Sometimes the IRS will determine that the foreigner is exempt from all withholding, and sometimes the IRS determines the foreigner is only partially exempt, or not exempt at all. This all depends on the treaty.

However, at all times, the IRS requires the foreign seller to have a federal identification number. Furthermore, the IRS will require a foreign buyer to have a federal identification number if the Application for Withholding Certificate is not filed by the seller, because the buyer’s federal identification number is required, in addition to the sellers, when remitting the 10%.

Most of us have a social security number, “SSN,” as our federal identification number. A business, trust, or estate has an employer identification number, “EIN,” as its federal identification number. All others have an individual taxpayer identification number, “TIN”, as a federal identification number. If a buyer or seller of a United States real property interest does not already have a federal identification number, this becomes a critical issue when you are trying to close the transaction, as it is required to be reported by the closing agent, and can take some time to obtain.

The foreigner will either apply for the federal identification number simultaneously with the Application for Withholding Certificate, or simultaneously with closing if an Application for Withholding is not filed by the foreigner first. If the foreigner is an individual, then the photo identification required to be filed with the IRS must be notarized, which can take quite some time, if the person does not have access to a U.S. notary. This delay is often unexpected if the foreign buyer and seller are not informed, and such delay may sometimes cause a transaction not to close at all.

If you think you may have a foreign seller or buyer, it is advisable to promptly address these issues in the real estate contract itself and then seek professional assistance so that the appropriate steps may be taken prior to closing.

Our e-newsletters are on a wide range of informative legal topics.
If you have received this e-mail by accident,
please e-mail us at info@farr.com and we will take you off our confidential e-mail list.

Statement required by U.S. Treasury Department: To the extent this message contains tax advice, the U.S. Treasury Department requires us to inform you that any advice in this letter is not intended or written by our firm to be used, and cannot be used by any taxpayer, for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code. Advice from our firm relating to Federal tax matters may not be used in promoting, marketing or recommending any entity, investment plan or arrangement to any taxpayer.