Is There a Federal Withholding Tax on the Sale of Real Property?

Selling real estate can come with unexpected tax obligations, particularly when it involves federal withholding requirements. In some cases, a portion of the sale proceeds must be sent to the IRS, impacting both buyers and sellers. Understanding these rules is essential to avoid surprises during a transaction.

Determining Applicability

Federal withholding on real estate sales depends on the seller’s residency status. Under the Foreign Investment in Real Property Tax Act (FIRPTA), buyers must withhold part of the sale price when purchasing U.S. real estate from a foreign seller. This ensures non-U.S. residents pay taxes on any gains from the sale.

A foreign seller includes individuals, corporations, partnerships, trusts, and estates classified as nonresident aliens or foreign entities. U.S. citizens and resident aliens are generally exempt. Residency status is determined based on IRS guidelines, including the substantial presence test and green card status.

The buyer is responsible for verifying the seller’s status, as they must withhold and remit the tax. To confirm the seller is not foreign, buyers typically request a certification of non-foreign status, which includes the seller’s name, U.S. taxpayer identification number (TIN), and a signed declaration under penalty of perjury. If this certification is not provided, the buyer must assume the seller is foreign and withhold the required amount.

Rate of Withholding

The withholding amount is based on the property’s gross sales price. Under FIRPTA, the standard rate is 15% of the total sale price.

For properties sold above $1 million that are not intended for use as a personal residence, the withholding rate increases to 30%. Buyers must be aware of this threshold, as failing to withhold the correct amount can result in penalties and interest charges.

Sellers can apply for a reduced withholding amount by requesting a withholding certificate from the IRS using Form 8288-B. If approved, the withholding amount is adjusted based on the seller’s actual tax liability. Processing can take several weeks, so sellers should apply well before closing.

Exemptions

Certain real estate transactions qualify for an exemption from FIRPTA withholding. One common exemption applies when the buyer purchases the property as a personal residence and the sale price does not exceed $300,000. The buyer must intend to use the property as a primary residence for at least 50% of the time it is occupied during the first two years after the sale. If these conditions are met, no withholding is required.

Some foreign sellers may qualify for an exemption if they have previously filed U.S. tax returns and met their tax obligations. In such cases, they can apply for a withholding certificate from the IRS to reduce or eliminate the required withholding. Unlike automatic exemptions, this requires proactive action by the seller, and approval must be obtained before closing.

Certain corporate transactions are also exempt. If the seller is a foreign corporation that has elected to be treated as a U.S. corporation for tax purposes, withholding may not be required. Additionally, sales involving publicly traded companies where the seller owns 5% or less of the entity’s stock are generally exempt. Buyers involved in corporate or investment property transactions should review the seller’s ownership structure and tax classification before assuming withholding applies.

Reporting and Payment Steps

Once withholding is collected, the buyer must remit it to the IRS. The buyer, as the withholding agent, must complete IRS Form 8288, “U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests,” along with Form 8288-A, which details the amount withheld. These forms and the withheld funds must be submitted to the IRS by the 20th day following the property transfer. Late submissions can result in interest charges and additional liabilities.

Form 8288-A must include the seller’s U.S. taxpayer identification number (TIN) to ensure proper crediting of the withheld tax. If the seller does not have a TIN at the time of sale, they must apply for one using Form W-7, “Application for IRS Individual Taxpayer Identification Number.” Without a valid TIN, the IRS will not process Form 8288-A, delaying the seller’s ability to claim a refund or apply the withholding toward their final tax liability. Buyers should confirm the seller has an active TIN before submitting the paperwork.

Penalties for Failure to Withhold

Failing to comply with FIRPTA withholding requirements can result in financial consequences for the buyer. Since the buyer is responsible for withholding and remitting the tax, any failure to do so can lead to penalties, interest, and potential legal issues.

If the required withholding is not submitted on time, the IRS may impose penalties equal to the full amount that should have been withheld, meaning the buyer could be held personally liable for the tax owed by the foreign seller. Interest accrues on the unpaid amount from the due date until payment is made. Late filing of Form 8288 can also result in additional fines.

If the IRS determines that the failure to withhold was due to willful neglect, further penalties may be assessed. This can include fines beyond the original withholding amount. To avoid these risks, buyers should conduct thorough due diligence when purchasing property from foreign sellers, ensuring all required forms are properly completed and submitted on time. Consulting a tax professional or real estate attorney can help ensure compliance with FIRPTA regulations.