ArticleM&A Tax Concepts: What is a “gross-up payment,” and why does it matter?
Transactions involving the disposition of a U.S. real property interest (“USRPI”) by a foreign person (i.e., a nonresident alien individual or foreign entity, the seller) are subject to the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”), and require income tax withholding, unless a specific exemption or exception applies. In any case, both the seller and buyer have separate considerations that they must address in order to properly navigate the FIRPTA rules, and discharge their respective responsibilities.
The various interests that constitute a USRPI are defined in the Internal Revenue Code and Treasury Regulations, but let’s consider a simple example of a nonresident individual who is selling their fee ownership interest in a multifamily investment property located within the United States. This transaction is subject to FIRPTA.
Accordingly, the buyer would be required to withhold and remit to the Internal Revenue Service (“IRS”) 15% of the gross purchase price. The withholding and remittance would be reported using IRS Form 8288, U.S. Withholding Tax Return for Certain Dispositions by Foreign Persons, and Form 8288-A, Statement of Withholding on Certain Dispositions by Foreign Persons. These forms generally must be filed no later than twenty (20) days after closing. Under the FIRPTA rules, the buyer generally is considered the withholding agent, which means that if the above procedures are not properly followed and/or the proper amount of withholding is not timely remitted, the buyer may be liable for additional tax, interest and potential penalties. Accordingly, buyers should ensure they are well-advised in their real estate transactions in order to properly identify whether their purchase is subject to FIRPTA, and if so, comply in all respects with the FIRPTA rules.
Sellers, on the other hand, likely are concerned that when their sale is subject to the FIRPTA rules, the required withholding amount (i.e., 15% of the gross purchase price) is well above any actual tax they would have been required to pay (i.e., if they were U.S. tax resident and subject to tax on their actual gain, as appropriate, under the Code). Sellers therefore should consult with counsel to (i) determine whether, and to what extent any exemptions or exceptions could apply to their sale; and (ii) to the extent of any potential elimination or reduction in withholding, follow the correct (but often complex) steps to ensure they receive relief.
A fairly common example is when a seller needs to apply for a “withholding certificate” from the IRS. Withholding certificates are typically obtained to prove that the sale is either exempt from withholding, or that the withholding can be reduced because the seller’s underlying tax liability will be less than the standard amount of FIRPTA withholding. Failure to take appropriate action and file the necessary application will result in the buyer withholding the full amount at closing. At that point, the seller would need to file a U.S. tax return in order to claim a refund – a process that is potentially difficult, disadvantageous, time consuming and costly. In addition, we have recently seen increased processing times for withholding certificates. It is imperative that taxpayers compile these applications correctly at the outset; otherwise, they risk significant delays that could complicate the transaction.
The above example and discussion are generalized and simplified, but make no mistake: the FIRPTA rules are many, and nuanced. Both buyers and sellers of U.S. real estate should seek counsel early on from tax and real estate attorneys who are familiar with these issues, so as to stay compliant on the one hand, and optimize the transaction on the other.
