U.S. Taxation of Disposition in Real Estate for Foreigners

According to the regulations of the Internal Revenue Service (IRS), Foreigners mainly include non-U.S. citizens or residents, as well as foreign entities are established outside U.S. (such as foreign corporations, partnerships, trusts, etc.). They generally are subject to U.S. income tax only on income that is U.S. Sourced. The common U.S. source income is shown below respectively: Effectively Connected Income (ECI) from U.S. Trade or Business, and Fixed, Determinable, Annual, or Periodical (FDAP) income and they should be subject to withholding tax based on the types of income. The following content focus on U.S. taxation of disposition in real estate for foreigners.

1. Methods of Acquiring U.S. Real Estate
   
   Generally, foreigners always acquire U.S. real estate for deriving the income from rental properties or the holding of real estate for capital gains. Thus, the common methods of acquiring real estate include as follows:
   
   

   (1)

   Directly held by Foreigners Foreign individuals or foreign companies (such as foreign corporations, partnerships, trusts, etc.) can directly purchase and hold U.S. real estate, which is simplest and most convenient method. However, the disposition of U.S. real property by foreign person is subject to FIRPTA (Foreign Investment in Real Property Tax Act of 1980) income tax withholding, therefore, foreign investors will be withheld the tax partially and is required to claim the refund from tax withholding or pay additional tax by filing of their U.S. tax return.

   (2)

   Indirectly held by U.S. companies Foreigners also can acquire and hold a real estate by establishing U.S. companies (C Corporation or LLC). According to IRS’s regulation, no FIRPTA withholding tax is required when purchasing, and holding by US LLCs are most popular way nowadays due to its flexibility on taxation and structures.

   
   
2. Withholding Tax on Sale or Other Disposition of U.S. Real Estate
   
   Gains on the sale or other disposition of U.S. real estate by a foreign individual are U.S. source income and treated as effectively connected with a U.S. trade or business. Foreign investors are required to pay FIRPTA withholding tax and states withholding tax or capital gains tax.
   
   

   (1)	FIRPTA Withholding Tax The disposition of a U.S. real estate held by foreign investor is subject to FIRPTA tax withholding. It is the buyer’s responsibility to withholding tax. Therefore, if you are the seller, there is no need to withhold and remit tax to IRS. If you are the buyer, you need to find out if the seller is a foreign person at first. If the seller is a foreign person, then the buyer of the real estate is required to withhold adequate tax amount in 20 days after the transfer, then to report and remit the withholding tax amount to IRS with filing of Form 8828 and Form 8828-A. As a buyer, FIRPTA requires withholding of up to 15% of the gross purchase price of the real estate (or its fair market value, if greater) for properties other than the buyer’s personal residence, and for personal residences sold for more than $1 million. For personal residences with a purchase price not in excess of $300,000, no withholding is required; for other personal residences, a 10% withholding rate will apply unless the purchase price exceeds $1 million. The FIRPTA withholding tax is not the actual U.S. tax due amount for the seller. If the withheld amount exceeds the actual tax due including the income tax and capital gain tax, then the foreign investor who dispose the real estate should receive a refund when file tax return. According to IRS, the 10% or 15% FIRPTA withholding tax amount from the disposition of a U.S. real estate interest can be reduced by a certain amount pursuant to a withholding certificate issued by the IRS. The 15% FIRPTA withholding tax can even be waived in certain cases if certain requirements are met, such as the purchase of owner-occupied, non-investment estate under $300,000 etc.
   (2)	Capital Gains Tax Gains on sales of real property held more than one year (“long-term capital gains”) in the US are generally taxed at 15% or 20% (depending on the amount of taxable income) for individual taxpayers.
   (3)	States Withholding Tax In addition to FIRPTA withholding tax, the disposition of real estate by foreign investor is also subject to state withholding tax in most states. Different withholding calculation methods will apply in accordance with the taxation and regulation in each state. For instance, California Franchise Tax Board requires that Form 593 must be submitted within 20 working days after completion of transaction and 3 1/3% of sales price amount should be withheld; and New York State Tax Department requires the seller to submit Form IT-2663 and withhold 10.9% of tax from gain of disposition of real estate.

   
   
3. Tax Reporting Related to the Disposition of U.S. Real Estate
   
   In general, when foreign investors sell or dispose of U.S. real estate, they must file tax returns by the designated deadline following the close of the tax year to request refunds or settle any tax liabilities. They are required to submit the appropriate forms based on how they hold the estate. The list below includes some common filing forms for reporting the disposition of U.S. Real Estate.
   
   

   (1)	U.S. Nonresident Alien Income Tax Return (Form 1040-NR) If the U.S. real estate is owned by a foreign individual or a single-member Limited Liability Company (LLC), they may report capital gains from the disposition of the estate by submitting Form 1040-NR, and then they will claim the refund from tax withholding or owe and pay additional tax for this reporting. It is important to note that late filing of tax returns and late payments may result in penalties imposed by IRS at applicable interest rates.
   (2)	U.S. Income Tax Return of a Foreign Corporation (Form 1120-F)   When a foreign corporation disposes of U.S. real estate, certain taxes are withheld by both the IRS and state tax authorities. Therefore, the corporation must report the capital gains or loss by filing Form 1120-F and determining their tax liabilities at 21% corporate tax rate and then apply for refund or arrange to make payment for additional tax.
   (3)	U.S. Return of Partnership Income (Form 1065) or U.S. Corporation Income Tax Return (Form 1120)   When a multi-member LLC sells U.S. real estate, it is required to file a U.S. Return of Partnership Income (Form 1065) and provide each member with the necessary supplement forms for their individual tax filing. Alternatively, the LLC may also make an election to treat as C Corporation and file a U.S. Corporation Income Tax Return (Form 1120) to report the capital gains from disposition.

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