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What FIRPTA Means for Your 1031 Exchange

David Gorenberg, JD, CES®
06/29/22
Section 1031 of the Internal Revenue Code allows the owner of business or investment real estate to dispose of their relinquished property and acquire replacement property without recognizing depreciation recapture tax or paying capital gains taxes on the profits at the time of the sale. How does the use of Section 1031 change if the owner of the property is a foreign citizen?
1031 Exchanges and FIRPTA for Foreign Citizens Owning US Properties

US Real Estate Ownership Among Foreign Citizens

According to the Congressional Research Service, foreign citizens own 3% of all US real estate, with investors from Canada, Netherlands, and Italy accounting for about half of that. As of 2019, the states with the highest number of foreign-owned acres were Texas (4.4 million acres), Maine (3.3 million acres), Alabama (1.8 million acres), and Washington and Colorado (1.5 million acres each). Arkansas, California, Florida, Georgia, Louisiana, Michigan, New Mexico, Oklahoma, and Oregon each report approximately 1 million acres owned by foreign citizens. What happens when these foreign owners want to sell their US real estate?

What is FIRPTA?

The disposition of any interest in US real property by a foreign taxpayer is subject to the Foreign Investment in Real Property Tax Act of 1980, commonly known as FIRPTA, income tax withholding. In short, what this means for the foreign seller of a US Real Property Interest is that the buyer of that interest must withhold 15% of the purchase price at the time of the sale. This applies to all transfers by foreign taxpayers – whether by sale, exchange, liquidation, redemption, gift, or otherwise. The recipient of the property – the buyer, transferee, purchasers’ agents, and settlement officers are tasked with holding back 15% of the purchase price, rather than paying it directly to the foreigner investor. If the transferor were a foreign taxpayer, and you, as the Buyer or settlement officer, fail to withhold those funds, you could be held liable for the tax.

FIRPTA withholding does include exceptions to the withholding rules. As applied to 1031 exchanges, the most relevant exceptions that allow you to disregard FIRPTA include:

It is important to note that the foreign Seller cannot submit the Form 8288-B until there is a valid real estate contract. The completed form should be submitted to the IRS promptly, and before the actual closing date on the sale. Any form submitted after the closing date will be deemed by the IRS to be untimely and require that the mandatory withholding amount be sent to the IRS within 20 days of the closing date.

As a practical matter, all of this has two key impacts:

  • 1031 exchange Buyer of a foreign person’s real estate – As the 1031 exchange Buyer of a foreign person’s real estate, you would be required to withhold 15% of the fair market value of the real estate, typically the purchase price, at the time of closing. More often than not, this task is completed by the settlement agent or escrow agent, but a prudent buyer would ensure compliance.
  • Foreign investor selling as part of a 1031 exchange – When the foreign investor is selling as part of a 1031 exchange, that investor is advised to submit Form 8288-B as soon as they have a contract for the sale of that property. If the 8288-B is not submitted before closing, the Buyer will be required to withhold, and to then remit, the 15% to the IRS by the 20th day after closing. It typically takes the IRS up to 90 days to process requests for refunds or exemptions using Form 8288-B.

Buyer s, closing agents, and Qualified Intermediaries such as Accruit are required to comply with FIRPTA withholdings. Whether you are a 1031 exchange buyer of a replacement property from a foreign taxpayer, or you are a foreign investor selling as part of a 1031 exchange, you should consult with your tax or legal advisors well in advance of the closing.