What you need to know about FIRPTA
Originally appeared in Hills Publications, Feb. 29, 2008 and ANG Newspapers, Mar. 1, 2008
Few buyers and sellers know about the 1980 “Foreign Investment in Real Property Tax Act” (FIRPTA). Likewise, many real estate licensees are not aware that failing to follow the act’s stipulations is a violation of Federal law.
This legislation was enacted to ensure that, upon selling, nonresident aliens who invest in U.S. real estate pay income taxes on any gain. If the seller is exempt because he is not in this category, he must complete a “Seller’s Affidavit of Nonforeign Status” and deliver it to the buyer before close of escrow. The form includes his taxpayer identification number (TIN). Normally, the TIN is the seller’s social security number.
If the seller does not comply with the above, the buyer can instruct the escrow holder to deduct, from the seller’s proceeds, 10% of the gross sales price and have that amount paid to the IRS to satisfy the seller’s Federal tax obligation.
Alternatively, the buyer can ask the escrow holder to put off the closing until the seller furnishes him with the completed Seller’s Affidavit. I have never seen or heard of either of these options being used by a buyer.
The law obliges the buyer to hold onto the Seller’s Affidavit for five years after escrow closes. Sellers are uniformly uneasy with the concept of having their social security numbers in the buyer’s possession for even a day, no less five years. This is understandable.
What if the buyer misplaces the paper or throws it in the trash without shredding? What if the buyer’s home is burglarized and the Seller’s Affidavit is stolen?
I do not have any comforting answers to these questions and this is why my sellers consistently refuse to include their social security numbers on the Seller’s Affidavit. Knowledgeable sellers sometimes tell me that the escrow holder will be having them complete a Seller’s Affidavit, including their social security numbers, along with other closing documents.
Unfortunately, this does not conform to the law because, 1) the escrow holder does not give the Seller’s Affidavit to the buyer before close of escrow; 2) the escrow holder may not retain the form for five years; and 3) the escrow holder may not agree to relinquish the Seller’s Affidavit upon the buyer’s request so he can give it to the IRS.
Penalties for noncompliance
If a seller has not paid appropriate taxes on the sale, the IRS could be looking to the buyer for the Seller’s Affidavit. Failure to present this might result in either the buyer or the real estate brokers being responsible to the IRS for the delinquent amount, plus possible interest and penalties. Although I do not know of any cases where this has happened, buyers and sellers should be counseled by their agent about the potential problems of not adhering to the law.
California nonresident withholding
The California Revenue and Taxation Code requires buyers to withhold 3 1/3 percent of the gross sales price if the seller is a nonresident of California or if the sales proceeds are to be sent to an address outside of California. The escrow holder forwards these funds to the Franchise Tax Board.
No withholding is necessary if the seller is a California resident and he completes the information, which is part of the FIRPTA documentation, attesting to his residency at the property he is selling for two of the last five years. There are other stipulations and exemptions, but California residency is the key one.
Realtors have been working with Congress to amend the law and eliminate the identity theft issue, so far without success.
As is true with many real estate requirements, FIRPTA is not always fully explained by agents to their clients. I have heard numerous comments about how it is a foolish law; however, despite the low likelihood that there will be any consequences, it is important to know that the law exists.