By:  Coleman Jackson, Attorney, CPA
October 05, 2016

Here are realities effecting buying and selling United States Real Property Interests to or from Foreigners:  Foreigners are subject to United States tax laws under certain circumstances.  Resident and nonresident aliens (foreigners) are taxed differently under U.S. tax laws.

Resident aliens (Green Card Holders and foreigners meeting the substantial presence test) are taxed in the United States, generally speaking, the same way United States citizens are taxed under 26 United States Code.  Resident’s are taxed on their worldwide income, from whatever source, the same as United States citizens regardless where they reside and regardless where the income is earned.  Resident foreigners use the same tax tables as U.S. citizens.

Nonresident foreigners (foreigners who do not meet the substantial presence test or Green Card) are taxed based on the source of their income and whether or not their income is effectively connected with a United States trade or business.  Nonresident foreigner’s income from sources within the U.S. is subject to U.S. income tax and must be separated into two pools as follows:

a) Income that is effectively connected with a trade or business in the United States, and
b) Income that is not effectively connected with a trade or business in the United States

Income in pool (a) is taxed at the same graduated tax rates as applied to U.S. citizens. Income in pool (b) is taxed at a flat thirty percent (30%) tax rate or lower tax treaty tax rate.

Special tax rules apply to nonresident foreigners purchasing or selling United States Real Property interest.  Gains and losses from the sale or exchange of United States real property interests are taxed as if the foreigner is engaged in a trade or business in the United States.

Moreover, special tax withholding rules under 26 U.S.C. (Internal Revenue Code) requires under certain circumstances for buyers buying United States Real property from a foreigner to withhold taxes unless certain exemptions are applicable.  United States real property interest is defined as real estate located inside the United States, and includes amongst other things, residential single family homes, multi-unit dwellings, commercial buildings and so forth.  It is extremely important to consult legal counsel concerning tax law implications; and other not so obvious legal hazards, when buying United States real property interest from a foreigner.  Your typical real estate agent or broker is not a lawyer and cannot lawfully advise parties in a real property transaction regarding tax implications and other legal jeopardy concerns associated with real property interest dispositions involving foreigners.

What exactly is the withholding requirement associated with buying United States real property interests from a foreigner?  Internal Revenue Code Sec. 1445 (a) imposes a duty on buyers to withhold income tax on dispositions of U.S. real property interests involving nonresident foreigners.   The law imposes legal liability on the buyer for the tax due on the transaction if the buyer fails to comply with IRC Sec. 1445 (a).

Any buyer or transferee purchasing or exchanging a United States real property interest with a nonresident foreigner before February 17, 2016 must withhold a tax equal to 10% of the amount realized on the disposition.  For U.S. real property interests purchased or exchanged with a nonresident foreigner after February 16, 2016, the rate of withholding is generally 15% unless the property is going to be used by the buyer as a residence and the amount realized does not exceed $1,000,000.  In that case, the withholding tax remains at 10%.  These withholding obligations are the responsibility of the buyer of U.S. real property interests from nonresident foreigners; which means, buyers are exposed to potential tax liability or jeopardy if they fail to withhold the required tax in the correct amount at the time of closing the real property transaction.  The withholding requirement is based on the gross amount realized; which means, real estate commissions are not subtracted in applying the correct withholding tax percentage.

This withholding provision potentially creates a genuine conflict of interest between a buyer and their realtor or broker.  Likewise a conflict of interest could likely exist between a nonresident foreigner selling  U.S. real property interests and their real estate agent or broker,  especially involving the exemptions availability and selection of buyers .  It is probably prudent for buyer and seller of real property interest involving nonresident foreigners to have their independent legal counsel separate and distinct from their respective real estate agents or brokers because tax laws are implicated with potential for substantial financial consequences could have impact on real estate selling decisions by buyers and sellers of U.S. real property interest involving nonresident foreigners. Also, nondiscrimination laws in sale and purchase of real estate in the United States could impact these transactions.

But as for the exemptions to the withholding requirement; the following are very broad generalizations concerning exemptions that could apply (depending on all the facts and circumstances) to the withholding requirements of IRC Sec. 1445:

The buyer is not required to withhold any amount under Sec. 1445 (a) if one or more of the following applies to the transaction:

1. The nonresident foreigner supplies an affidavit testifying that they are not a foreign person;
2. Private domestic corporation supplies an affidavit testifying that their interests in the corporation is not an United States real property interests;
3. IRS issues a qualifying statement to buyer (or seller) satisfying the requirements set forth in IRC Sec. 871(b)(1) or 882(a)(1);
4. The amount realized on the U.S. real property interests transaction does not exceed $300,000 and the buyer intends to use the real property as its residence; or
5. A wash sale is involved pursuant to IRC Sec. 8997(h) (5).

These exemptions have been abbreviated and only state the basic nature of the statutory exemption.  As with any statute effected parties must consult the applicable Internal Revenue Code Section(s), Internal Revenue Regulation(s), Revenue Ruling(s), Tax Court Opinion(s) and decision(s) of other Courts having interpreted and established precedence regarding how and when these tax withholding exemptions might or might not apply to withholding of tax on dispositions of United States real property interests involving nonresident foreigners.  Anyone buying or selling U.S. real property interest to a nonresident foreigner should perform their due diligence prior to entering an earnest money contract or any other kind of contract of purchase.  Likewise foreigners should perform their due diligence regarding applicable tax laws and other U.S. laws before entering into U.S. real property interest transactions involving nonresident foreigners.  Unintended tax consequences could lurk behind every U.S. real property interest transaction involving nonresident foreigners as well as exposure to unintended consequences of other state and federal laws governing disposition of real property interest.

This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader.  You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.

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