July 22, 2014--Don't Forget the FIRPTA: Inattention to detail can cause big problems...
Important Paper Shuffling
Those of you who have attended a closing, know things pick up speed once the bank is ready to fund and all the documents have been signed. The representative of the managing agent or the title closer exits the closing room to handle the photocopying. The seller, purchaser and other usual suspects wait eagerly for the festivities to draw to a close. Invariably, in all the excitement, a document can get left out of a party's share of the paperwork. It's usually fixable after the closing. Leaving without the "FIRPTA", when it turns out the seller is a foreign citizen, can create huge problems for the purchaser and potentially significant financial exposure.
What Exactly is a FIRPTA?
Under the Foreign Investment in Real Property Tax Act, a purchaser of real estate is given significant filing and payment obligations on behalf of the seller. When the seller is a not a U.S. citizen, the purchaser must collect a withholding of 10% percent of the purchase price and remit same to Internal Revenue Service within 20 days after the closing. If the purchaser fails to make the withholding payment, or fails to remit the payment on time, the purchaser, as "withholding agent", will be responsible for the failure to withhold and for the late payment. In order to remove the withholding obligation at closing, the seller must certify that the he or she is not a foreign person. Once the purchaser obtains this certification, affectionately referred to as the "FIRTPA" or "FIRPTA Certification", a withholding is not required. If the purchaser fails to obtain the FIRPTA and it turns out a withholding is required, serious problems arise. As the withholding agent, the purchaser, not the seller, will be held liable for the payment of the withholding that is due. Penalties and interest are significant and mount up quickly. You can see the possibility for a crisis: the seller has left the United States, or perhaps was never in the United States and the purchaser is left with a significant financial obligation that will be charged against the purchaser's Social Security number. It is a very scary scenario. And the IRS will ultimately find out. As the parties are required to file a “1099” with IRS indicating the sale and the amount of proceeds, sooner or later, the IRS will determine whether the seller is a foreign citizen.
Standard Operating Procedure
In the vast majority of cases, the FIRPTA is delivered at the closing and the issue of the seller’s citizenship is resolved as far as the purchaser is concerned. If the seller is a foreign person and submitted a false certification, there will be big problems for the seller, but the purchaser is relieved of liability, assuming the purchaser had no knowledge of the fraud perpetrated by the seller.
It often turns out that a foreign citizen owes a capital gains tax payment to IRS that is less than the full amount of the withholding (that is, 10% of the purchase price). IRS has a procedure that allows a foreign citizen to apply for a "Withholding Certificate" which determines the actual amount of tax that the individual owes. If the Withholding Certificate is issued prior to the date of closing, then the purchaser, as withholding agent, is only required to submit the reduced payment that is reflected in the Withholding Certificate. In the old days, the Withholding Certificate would take less that 30 days to obtain, so the seller was able to take advantage of the procedure and make the reduced payment. The IRS of 2014 is quite different. The issuance of a Withholding Certificate can take four or five months and is usually not available at the time of the closing.
Now for the Tricky Part
To accommodate the infuriatingly slow pace at which IRS does things, there is yet a Plan C. Provided that the seller has applied for the Withholding Certificate prior to closing, if the purchaser's attorney is willing (to be discussed below), an escrow can be held by the purchaser's attorney at closing, equal to 10% of the purchase price, pending the issuance of the Withholding Certificate some months down the road. Once the Withholding Certificate is issued, the reduced payment set forth in the Withholding Certificate can be remitted to IRS and the balance held by the purchaser's attorney can be returned to the seller. If there were ever a situation in which the phrase "no good deed goes unpunished" applies, it would be in the reference to this post closing FIRPTA escrow.
Just Say No
Consider this, there is absolutely no benefit to the purchaser to agree to a post closing escrow and potential liability if the Withholding Certificate is delivered to the purchaser’s attorney after the payment due date. As I recently found out the hard way, even if you make the payment on time and as required in all respects, IRS can make a mistake and take the position that the payment was not made on time. When that happens, the liability for the mistake by IRS falls on the purchaser and not the seller. What makes the potential for chaos even greater is that the IRS is so short staffed at the moment, there are very few people there who have any idea how the FIRPTA process works. That's assuming that you can get someone on the phone, which I can attest is a challenge in itself. In my own situation, every call to IRS required at least a 30-minute wait, before I got to a human being. In the vast majority of the calls I made, the person I spoke with, after taking an extensive history of the events that had taken place, switched me to another party, who invariably was not available. IRS will eventually acknowledge the mistake and credit the taxpayer’s account accordingly. But much time, effort and expense will be incurred before that happens.
What are We Talking About, Really?
This potentially nightmarish process was invented so that a foreign seller would not have to wait until the April following the closing to seek a refund. At the end of the day, it simply is not worth the effort and potential risk to the purchaser to allow the escrow to be held at the closing in lieu of just making the required 10% withholding payment. Perhaps, if IRS were not completely dysfunctional, at least insofar as foreign tax matters are concerned, it might be considered, but under the current state of affairs, don't go there...
I Keep a FIRPTA in my Briefcase
At a closing recently, when I asked the seller's attorney for the FIRPTA, she replied, "Oh I haven't asked for one of those in years." I removed a blank form from my file and had the seller complete it.
Residential Reality: Stay Ready, So You Don't Have to Get Ready...
With the market flooded with foreign purchasers and sellers, focusing on the citizenship status of the seller has never been more important. Make sure the FIRPTA is delivered at the closing and stay far away from post closing FIRPTA escrows...