Can Foreign Investors Participate in 1031 Exchanges when Selling their Property in Florida?

Foreign investors often wonder whether they can use 1031 exchanges to defer capital gains taxes in the U.S. when selling real estate. This article explains the key aspects of FIRPTA (Foreign Investment in Real Property Tax Act) and how it affects foreign sellers, as well as the requirements for using a 1031 exchange.

Understanding FIRPTA Withholding Rules

When purchasing U.S. real estate from a foreign seller, buyers, escrow agents, and closing agents must comply with FIRPTA’s federal withholding requirements. Under FIRPTA, if a foreign person or entity sells U.S. real estate, the buyer is required to withhold up to 15% of the “amount realized” from the sale. The “amount realized” includes not just the cash proceeds but also any mortgage balance assumed or encumbering the property and any non-cash property involved in the sale. Because of this, the amount withheld could sometimes exceed the cash available at closing.

Basic FIRPTA Rules

Withholding is only necessary when the seller is considered a foreign person or entity. This includes non-resident aliens, foreign partnerships, trusts, estates, and certain foreign corporations. If the seller certifies under penalty of perjury that they are not a foreign person, the buyer may rely on this certification, unless the buyer has actual knowledge to the contrary. In this case, no withholding is required, but the buyer must keep the certification for five years after the transaction.

If the seller is a foreign person or entity, the buyer must withhold 15% of the sale price and remit it to the IRS within 20 days of closing. Failure to do so makes the buyer liable for the withheld tax, as well as any associated penalties and interest.

Although often referred to as a “15% tax,” FIRPTA withholding is not a final tax amount. If the foreign seller’s actual tax liability, upon filing a U.S. tax return, is lower than the withheld amount, the excess is refunded. Conversely, if the tax liability exceeds the amount withheld, the foreign seller will owe the difference.

Withholding Certificates

If the foreign seller anticipates that their actual tax liability will be lower than the 15% withholding, they can apply for a withholding certificate to reduce the amount withheld. This is done by submitting IRS Form 8288-B, which acts as a mini-tax return and must be filed before closing. The IRS typically takes around 90 days to process the form. During this time, the buyer must still withhold the 15%, but can wait to remit the funds until receiving the IRS's response. Once the IRS issues its decision, the buyer must send the required withholding amount within 20 days.

FIRPTA Withholding Exceptions

Use of Property as a Home
No withholding is required if the sale price is $300,000 or less and the buyer intends to use the property as their home. If the sale price falls between $300,000 and $1,000,000, and the buyer plans to use the property as a home, then 10% of the amount realized must be withheld. The buyer (or a family member) must intend to live in the property for at least 50% of the time it is occupied in the two years following the closing. Vacant days do not count in this calculation.

1031 Exchange Misconception
Many people believe that foreign sellers can avoid FIRPTA withholding by participating in a 1031 exchange. While it’s true that foreign sellers previously could avoid withholding by notifying the buyer of their intent to do a 1031 exchange, the IRS has changed its approach. To qualify for an exemption from FIRPTA withholding in a 1031 exchange, the following conditions must be met:

1. The closing of the relinquished property must occur simultaneously with the purchase of the replacement property.
2. There must be no "boot" (additional non-like-kind property) in the exchange.
3. The seller must notify the buyer that no gain or loss is to be recognized.
4. The buyer must provide the IRS with a copy of the non-recognition notice within 20 days, confirming these conditions are met.

Adding Funds to Complete an Exchange

Foreign sellers can use personal funds to cover the FIRPTA withholding in order to maximize the cash available for a 1031 exchange. This approach is similar to when a seller adds cash to a closing to cover tenant security deposits, rather than providing a credit to the buyer. The buyer can then use the full proceeds from the sale to reinvest in the exchange.

Conclusion

This article covers only the basics of FIRPTA withholding, but it's important to consult with a tax advisor or legal professional to understand all of the rules and requirements. If you're structuring your transaction as part of a 1031 exchange, our team has access to a network of experienced lawyers, accountants, and tax specialists who have worked with international clients. Their expertise will be at your disposal when you choose to partner with us to help you navigate the process and ensure a smooth transaction.

For more detailed information, visit the IRS website at www.irs.gov.

Legal Disclaimer:
The information in this article is for general informational purposes only and should not be considered as legal or tax advice. Always consult with a professional attorney, CPA, or tax advisor for guidance tailored to your specific situation.

Source: "Can Foreign Investors Do 1031 Exchanges?" published in the First American Exchange website https://www.firstexchange.com/Can-foreign-investors-do-1031-tax-deferred-exchanges