How FIRPTA affects a 1031 Exchange

What is FIRPTA? It stands for the Foreign Investment in Real Property Tax Act of 1980. The IRS created FIRPTA to assure that foreign owners of assets (like real estate) paid their taxes when they are sold. The act requires that a portion of the sales price be withheld by the settlement agent to cover taxes on the gains made on the property.

It is commonly believed that the FIRPTA can be deferred by doing a 1031 Exchange. This is not correct. The settlement agent closing your relinquished property will still be required to withhold 15% of the purchase price for submittal to the IRS. This withhold will cause a taxable liability for your 1031 Exchange as a portion of the funds were not deposited with the Qualified Intermediary.

Taxpayers can apply to the IRS to receive a withholding certificate from the IRS to that FIRPTA is not collected. This process can take a few months, so you must plan ahead. Most taxpayers do not think about it until they are under contract on their sale, so they do not have time to apply for the waiver.

Another way to handle this would be to pay the 15% FIRPTA withholding with out of pocket cash. The seller would deposit the withholding amount to the settlement agent. That amount would be sent to the IRS and then all of the proceeds would be deposited with the Qualified Intermediary. When you file your tax return for that year, you would receive a refund of your withholding amount if there is no tax liability due.

Lastly, if the buyer in the transaction plans to occupy the property as their primary residence, there is no withholding requirement on properties with a sales price of $300,000 or less. But in this scenario, the buyer must live in the property as their primary residence for the next 2 years. If the sales price of the property is $300,000 to $1,000,000, the withholding is 10%. If the sales price is over $1,000,000, the standard rules apply.

It is wonderful that foreign investors can take advantage of the 1031 Exchange, but there are other issues (like FIRPTA) that they must consider. Please follow this link to the IRS website to review under what circumstances FIRPTA withholding would not be required - https://www.irs.gov/individuals/international-taxpayers/exceptions-from-firpta-withholding

For additional information, please reach out to your tax professional for specific questions or contact the specialists here at Security 1st Exchange for assistance.