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The Foreign Investment in Real Property Tax Act (FIRPTA – In A Nutshell)

Federal Requirements –

There are reporting and withholding requirements for a purchase of property from a foreign person or corporation (IRC §1445). Exchange Intermediaries should be familiar with the basic rules.

Any person who acquires an interest in U.S. real property from a foreign person or corporation must withhold and remit to the Internal Revenue Service a tax in the amount of 10% of the sales price. Form 8288 is used to report and remit the withheld amount.

Although the closer may perform the withholding and preparation of Form 8288, the burden of responsibility is on the buyer of the property. Often closers are not acquainted with these withholding requirements. Failure to withhold the tax may result in the buyer of the property being held liable for the payment of the tax and any applicable penalties and interest. A lien could be placed on the property if it is determined that the buyer failed to comply with the withholding requirement and is found to be liable for the tax.

There are exceptions to the withholding requirement.

  • Purchase of a Residence – Withholding is not required if the buyer is acquiring the property for use as a residence and the purchase price is $300,000 or less. No form is required to be prepared for the buyer or filed with the IRS for this exception.
  • Notification of Nonrecognition Treatment – Withholding is not required if the seller of the property notifies the buyer of the property that the seller is not required to recognize any gain on the sale under Code Section 1031. No particular form is required for the Notice. It is the buyer's duty to provide a copy of the notice to the IRS within 20 days of the closing date. A Notice of Nonrecognition Treatment cannot be used unless the 1031 Exchange is tax-deferred in its entirety (no cash or debt reduction boot). In this case, a Withholding Certificate must be obtained. And, if the buyer has reason to know that the sale is not qualifying under IRC 1031 for nonrecognition treatment, the buyer is not excused from the withholding requirement.
  • Withholding Certificate – Withholding is not required or can be reduced if the seller (or buyer) of the property files Form 8288-B with the IRS to obtain a Withholding Certificate. The IRS will normally respond to the notice by the 90th day after the application is received. This form relieves the buyer of the property from any responsibility for withholding other than what the Notice specifies and is the desirable method for assurance of compliance with FIRPTA. The buyer of the property should obtain a copy of this form for his files.

Compliance with FIRPTA in a 1031 Exchange

Simultaneous Exchange – Under the FIRPTA Rules, the above referenced Notification of Nonrecognition Treatment is sufficient to protect the buyer when the exchange is simultaneous and the foreign person receives no cash or debt reduction boot. However, if the foreign seller is receiving boot, the buyer will have a concern about responsibilities for withholding. Withholding is 10% of the sale price unless a Withholding Certificate is obtained from the IRS in advance which authorizes a lower amount of withholding tax. The closer (on behalf of the buyer) is required to retain the 10% until a Withholding Certificate is received. Advance planning is necessary if the seller is going to receive any taxable cash or debt reduction boot.

Delayed Exchange – If the foreign seller is participating in a delayed exchange the buyer can only rely on the above referenced Withholding Certificate to be held harmless for FIRPTA withholding. A notice of nonrecognition treatment cannot be used. Absent a Withholding Certificate, the buyer is responsible for withholding 10% of the sale price at the closing of the relinquished property. The closer (on behalf of the buyer) is required to retain the 10% until a Withholding Certificate is received. Obviously, advanced planning is required.

If the foreign seller has engaged an Intermediary to assist him with a Delayed 1031 Exchange, it is possible that the Intermediary may be deemed to be the buyer of the property and be liable for payment of the withholding tax even though the FIRPTA Regulations do not take this position. Even though the Intermediary does not ordinarily take title to the Replacement Property and the Regs do not address the Intermediary as the buyer of the property, the Intermediary may be deemed to take and convey ownership of the property by virtue of its responsibilities under the Exchange Agreement. Also, the buyer of the property may insist that title pass through the Intermediary for assurance that the obligation for the FIRPTA has been shifted to the Intermediary. If the foreign seller is receiving any cash or debt reduction boot from the exchange, the Intermediary should consider withholding tax on the cash or debt reduction boot to be received by the foreign seller.

This possibility should be provided for in the Exchange Agreement or an addendum thereto. The withholding requirement is 10% of the selling price of the property unless a lesser withholding amount can be obtained from the IRS. The Intermediary would be required to withhold 10% of the selling price until the Withholding Certificate is received and at that time would remit the balance to the exchanger. Again If this is anticipated, the exchanger should plan ahead and apply for the Withholding Certificate in advance.

State Requirements –

Many states have legislation similar to FIRPTA for nonresident sellers of property. All of the concerns that apply to the federal rules also apply to the requirements of each state. Intermediaries must check the requirements of the appropriate state legislation to determine the FIRPTA requirements of each state.

Colorado requires a tax of 2% of the sale price be withheld by the closer of the property unless an affidavit is filed by the seller with the closer that the sale is exempt for various reasons, including a nonrecognition transaction. Usually the title company or an attorney is the closer of the property. A seller would be deemed to be the "closer" if the services of a professional are not used. It seems that the Intermediary in a 1031 Exchange has very little to worry about in Colorado unless the seller is the closer. In any event, the burden is on the closer and not the buyer of the property.

California requires the Intermediary to withhold and pay tax to the Franchise Tax Board at 3 1/3% on cash remaining in an exchange account at the end of an exchange, or 3 1/3% on the entire sale price if the exchangor cashes out completely from an exchange. This withholding requirement applies to all resident and non-resident individuals of California, and non-resident, non-individual tax entities. Resident non-individual tax entities are excused from withholding tax. Thus, Intermediaries must monitor the exchange closely for compliance with California FIRPTA requirements.

Other states may have similar requirements.

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