Withholding exemption -- under $300,000 and buyer uses as primary residence
I've had a number of inquiries recently about how to avoid the 10% Federal withholding tax for lower-priced residential property. The rules are a bit confusing, so here's the simple explanation.
We're starting from the assumption that you have a nonresident seller of U.S. real estate (residents are exempt from withholding). When the sale price is $300,000 or less, the seller can avoid withholding if the buyer is going to use the property as a residence.
REQUIREMENT NUMBER 1: $300, 000 or less
The first requirement is that the sale price be $300,000 or less. One penny over the limit and the 10% withholding is required. There is no slack in this rule!
REQUIREMENT NUMBER 2: BUYER IS A HUMAN
The buyer must be an individual (or couple).
REQUIREMENT NUMBER 3: BUYER USES PROPERTY AS RESIDENCE
The final requirement is that the buyer must use the property as a residence. Note that the seller's use of the property is irrelevant. We only care about the anticipated use by the buyer. This is where things get a bit murky and difficult to understand. Here's the simple explanation
The buyer doesn't have to use the property as his or her sole residence. It need not be the buyer's principal residence. It need only be "a" residence that the buyer uses.
But the buyer must use it "enough" to qualify for the exemption from withholding. "Enough" means that in the first 12 months of ownership the buyer (or family members) will physically occupy the property for at least 50% of the time that the property is used at all. In other words, delete the number of days the property is vacant, and only look at the number of days that humans are inhabiting the property. Divide that number by two. That's the minimum number of days the buyer must occupy the property as a residence.
The buyer isn't safe yet, though. Make the same calculation for the second 12 month period. Will the buyer occupy the property as a residence for at least 50% of the time in the second 12 month period, too?
WHO'S AT RISK?
Usually it's the foreign seller who wants the exemption from withholding. The buyer could care less: the purchase price is the same whether 10% gets shipped off to the IRS or not. In short, it's the seller's problem.
But it becomes the buyer's problem if withholding should have been done, but wasn't. So if the buyer does the seller a favor and signs off on this exemption, what happens if later the buyer DOESN'T live in the property for the correct amount of time? Simple answer: potentially the buyer is on the hook after the fact for the withholding.
There are ways to get out of this. E.g., if you didn't live there long enough as the buyer because of changed circumstances, the IRS will give you a hall pass. But nevertheless the buyer has a risk hanging over his or her head and will have to pay a tax lawyer or accountant some big fees to get the IRS to go away. You hope.
WHAT'S IN IT FOR THE BUYER?
So why would the buyer sign off and give the seller this benefit? I can only think of three reasons:
* The buyer is a really nice person who wants to help people, even at a risk of paying the seller's taxes.
* The seller bribes the buyer to sign off on the exemption by reducing the purchase price.
* The sale is a deferred payment sale, so there is not enough cash at closing to pay the withholding tax. Then the only way the buyer can make the sale work is to sign off on the exemption.
HOW DO YOU DO IT?
So let's say you're a nonresident seller and you have a pliable buyer. How do you achieve this exemption from the 10% withholding?
There is nothing that needs to be filed with the IRS. No forms, no statements, nothing.
But there is usually a settlement agent in the middle of your transaction who cares very deeply about withholding (the settlement agent's neck is on the line in the case of withholding mistakes). The settlement agent may be an escrow company, title company, or lawyer, depending on where the property is.
How do you persuade the settlement agent that this is the way to go? Simple answer. You're going to have to affirmatively tell them this is what you want. and work with them and their procedures. Settlement agents -- if they get this stuff wrong -- are personally on the hook for the withholding tax. So they have an incentive to eliminate their risk.
Settlement agents are aware of this exception. They might not know the intimate details, but they know that it exists. Be polite, work with them. You'll get the exemption by -- usually -- having the buyer sign the right kind of declaration about intent to use the property as a residence in the next 24 months.
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At last a clear, comprehensible and very relevant article about withholding exemption for lower-priced residential property! Thanks very much, Phil!!
I am a Canadian who owns a small lot at Port St. Lucie, Florida. For years it was worth very little ($3000-$5000). Suddently the area has started developing and it is now worth $30000-$35000. I would like to sell the lot, which is in a residential area. And of course I would like to be exempted from withholding. Hence my question: what you say is clear if the property sold is a house which the buyer will have to use as a residence, but what if it is a vacant lot on which no building has been constructed yet? Does the requirement "buyer uses as primary residence" then vanishes? Or does an analogous requirement then applies, e.g. that the buyer will not be allowed to sell the property before a certain time? Your comments will be greatly appreciated. Thanks in advance! C. Gaulin
Aloha from Hawaii,
My fiance and I are selling his home here in Hawaii. He is a Swiss Citizen, but has lived in the house for 10 years (owner/builder). We need some advise regarding the firpta tax. We were told that if we could prove that we are taking a loss on the property that we may be able to get an exemption.
Can you help us with any information regarding this?
Thank you very much!
Amber:
Yes, you will be exempt from the FIRPTA withholding tax if you can prove that you're selling at a loss. Go to www.irs.gov and get Form 8288-B. This is the application form for getting exemption from withholding.
Key piece of information: get this thing FILED in Philadephia with the IRS _BEFORE_ the sale closes. It's a bit complicated but you don't want the taxes to get sent off to the IRS--you want them held locally by a neutral party for your benefit, until you get word from the IRS that zero withholding is permitted.
Recommended: work with someone -- title company, escrow company, accountant, lawyer -- who's been down this road before. If, when you say "FIRPTA," they look at you as if you have three arms, go find someone else. :-)
Claude Gaulin:
I don't think the exception will work for the sale of your lot. Here's why.
The exception only says that the property must be actually used as a residence for 50% of the days in a year.
Practically speaking, construction takes two days less than forever to complete. Thus I don't think a buyer is going to certify to you that he/she/it will use the property as a residence.
Phil. Similar to C. Gaulin, I have property (lot only) in Lake Placid area of Florida that was bought in 1978 for about $7800 US. I have an offer for $4750 US that I want to accept. How do I avoid this 10% withholoding? I notice on this site that you never replied to C.Gaulin's inquiry. Thank you...John
John:
The comment immediately above yours is my response to C. Gaulin.
As for your deal, if you make an application for withholding reduction on Form 8288-B you will be able to eliminate the withholding tax. Basically you are proving (on Form 8288-B) that you are selling at a loss, and therefore you have zero tax liability. As a consequence the withholding will be reduced to zero.
But there's a practical matter. Look. The withholding on the lot sale will be $475. That's peanuts. It will be 10,000 times easier for you to concede the withholding, then file a U.S. income tax return (Form 1040-NR) to get a refund. That's what I would suggest. The Form 8288-B process will take a long time and it's a pain to fill in the form and attach all of the exhibits. And technically speaking you have an obligation to file a U.S. income tax return for the year of sale anyway.
Phil.
I am US buyer in the process of buying a home from a German couple in Florida. They have asked us to sign an affidavit for exemption from withholding (due to the home cost being less that $300,000 and us planning on living in there for 2 years). We plan on being there for two years, but what I am concerned about is what other risks are we taking, as buyers, if we allow the exemption for withholding. Are there any other tax implications that we’d be responsible for if, for example, they didn’t pay their appropriate taxes? I don’t want to end up getting stuck paying their taxes if they don’t do things properly on their side. I don’t think they are the type that would do that, but I am trying to cover myself.
Thanks for your help!
Mike
10% withholding for foreing seller. Ok say the seller does not want to waive the withholding requirement. When can the seller (if ever) apply for the amount withheld?
thanks
Steve Imhof
Realtor
Mike:
In response to your dilemma, the answer is that you control your own destiny. Stay in the place the required number of days over the next 2 years, and you're home free, tax-wise. If you don't, you may have troubles. I say "may" because there are sometimes exceptions that apply -- what happens if you have to move for employment reasons, etc.?
But really you have to assume the worst. If your seller is asking you to sign the waiver, you can guess that there is no incentive for the seller to file and pay U.S. income taxes on the profits. So by strong assumption you're dealing with someone who is creating a U.S. tax problem for themselves.
And why would you willingly put yourself into the jackpot and run personal risk unless you're getting paid to take on that risk?
Here's what to do. With a bit of sleuthing you might be able to figure out what they paid for the property. Then you can figure out their profit. You calculate the tax they're SUPPOSED to pay. Cut that in half. Ask them for that much money in cash in order to sign the waiver. Then watch and see what they do.
Steve Imhoff:
I'm not sure, but I believe your question is as follows: let's assume the buyer won't sign the waiver to eliminate the withholding. What are the seller's choices then?
Two answers. (1) Apply for reduced withholding (use Form 8288-B). (2) Resign yourself to the withholding, then file a U.S. income tax return (Form 1040NR) and get a refund of whatever you're due.
Please note that no matter what happens on the withholding side of life -- waiver or no waiver -- the seller is still required to file a U.S. income tax return reporting the sale of the real estate. If the withholding is too small, the seller is supposed to send a check to the U.S. Treasury for the difference. If the withholding is too large (i.e., the withholding is higher than the calculated actual tax liability) the seller will get a refund of the difference.
OK, thanks for the post. Had a little difficulty finding my original post.
Thanks for the info Phil... I don't think we're going to sign it.
Have you addressed the notion that backup withholding or not, the seller still needs to file a US tax return and pay tax on any gain. Isn't the backup withholding simply a vehicle to make sure the tax is paid? If backup withholding isn't done, isn't the seller still ultimately responsible for paying the tax on the gain?
Mark Bennett:
You are completely right. No matter what the withholding situation, the seller is still obliged to file a U.S. tax return for the year of sale and settle up any tax debts to the U.S.
It might shock you to learn that some foreign sellers of U.S. real estate do everything they can to eliminate withholding, then . . . gasp! . . . never file tax returns and never pay U.S. taxes.
And that is a real risk for a buyer signing off on the "under $300,000 and a principal residence" exception. The odds are good that the foreign seller simply will walk away from the tax obligation.
I'm turning off the comments on this topic. It attracts too much comment spam.
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