THE INTERNATIONAL TAX ADVISOR

by:  Douglas J. Kingston, CPA/MBA  • Mailing Address: 16443 N 59th Place; Scottsdale, AZ 85254

• Telephone: +1 (602) 595-5885 (GMT-7) • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/

FIRPTA WITHHOLDING ISSUES INVOLVING LLC’S

 

Background

 

 

Exemptions from Withholding

 

 

Entity Classification

 

 

LLC Treated as Disregarded Entity

 

 

LLC Treated as Partnership

 

 

LLC Treated as “C” Corporation

 

 

Sample Picture

 

It is important for foreign investors to plan their investment in U.S. real estate carefully because U.S. taxation varies significantly depending on the type of ownership structure.

 

I frequently encounter misunderstanding and improper implementation of the FIRPTA withholding tax rules among real estate owners and their legal, accounting and real estate advisors. One particular area of confusion is application of those rules where either the buyer or the seller is a limited liability company (LLC) with one or more foreign owners. Until recently, lack of IRS guidance specifically dealing with FIRPTA and LLC’s was to blame for this situation.  In view of the proliferation of LLC’s as entity of choice for owning real estate and the continued popularity of U.S. real estate with foreign investors, and increased IRS scrutiny, the following information should be of increasing importance to real estate buyers, sellers and their advisers.

 

Background

 

By way of background, the FIRPTA withholding rules were enacted to impose tax payment and reporting liability on the buyer, and certain others involved in the transaction, to ensure collection of a foreign seller’s tax on disposition of U.S. real property.  Unless a transaction is exempt from withholding, the buyer must report the transaction and pay the required FIRPTA withholding to the IRS generally within 20 days.  The seller must subsequently file an annual income tax return reporting all U.S. income, reflecting any FIRPTA withholding as a prepayment of tax, and pay any balance due or claim any allowable refund.  Two prior articles dealt with the minutia of these rules applicable to dispositions of U.S. real estate owned directly by foreign individuals or indirectly through legal entities.

 

Exemptions from Withholding

 

The most common exemption from withholding applies if the seller is not a foreign person.  A “foreign person” includes any of the following: a foreign individual, a foreign corporation, a foreign partnership, a foreign trust or a foreign estate.  An individual is foreign if neither a U.S. citizen nor a U.S. tax resident, a corporation is foreign if organized outside the U.S. and a partnership is foreign if formed outside the U.S. (this determination for trusts and estates is complex). To qualify for this exemption, the buyer must obtain a written “certification of non-foreign status” signed by the seller under penalties of perjury. The certificate provides no protection from liability if the buyer has “actual knowledge” or receives notice from an agent that it is false. Buyers in transactions involving entity-sellers should be aware that IRS regulations effective September 5, 2003 require new language which must be included for a valid certificate – this language is available on my website by clicking here.

 

Another common exemption applies to sales of residential real estate not exceeding $300,000 where the buyer uses the property as a personal residence.  This exemption is available to an LLC-seller, but not to an LLC-buyer (IRS rules provide the exemption does not apply where the buyer is “other than an individual”).

 

Entity Classification

 

FIRPTA withholding rules impose different requirements depending not only on foreign or domestic status, but also on entity classification if a seller or buyer is not an individual.  Application of

 

 

Entity Classification (cont’d)

 

the rules to LLC’s is difficult since, for U.S. Federal

tax purposes, LLC’s are classified under one of at least four different tax code regimes: those applicable to individuals, partnerships, or “associations” (generally “C” or “S” corporations). IRS rules classify an LLC under the so-called “default rule” unless a timely election is filed for an alternate classification. For an election to be valid it must generally be filed within 75 days of the desired start date. FIRPTA exemption issues, and the default classification, for each type of entity are discussed below (other than for “S” corporations since, by definition, they may not have a foreign owner).

 

LLC Treated as Disregarded Entity

 

New IRS regulations effective September 5, 2003 provide that an LLC-seller characterized as a disregarded entity cannot issue a valid exemption certification, thus requiring withholding if the owner of the LLC is a foreign person (reasoning that the owner of the LLC, not the LLC itself, is considered to own the U.S. real estate for tax purposes). In this regard, the new certificate of non-foreign status includes the additional stipulation that the entity is not a disregarded entity.

 

Under the default rule, a single-member domestic LLC is disregarded as an entity separate from its owner, unless the owner files an election with IRS to classify the LLC as a “C” corporation. The IRS has ruled it will accept the position that a community property LLC is disregarded if the owners treat it as such.

 

LLC Treated as Partnership

 

A domestic LLC classified as a partnership may issue a valid certificate of non-foreign status even though one or more of its owners may be a foreign person (thus relieving buyers from FIRPTA liability).  However, owners of a selling LLC classified as a partnership should be aware that 35% (or lower capital gains) tax must be withheld and reported quarterly with respect to each foreign owner’s share of U.S. income or gain. 

 

The default classification for a multi-owner domestic LLC is as a partnership unless a timely election is filed to be classified as a “C” corporation.

 

LLC Treated as “C” Corporation

 

A domestic LLC classified as a “C” corporation may issue a valid certificate of non-foreign status even though one or more of its owners may be a foreign person.

 

Since corporate classification is never the default classification for a domestic LLC, a timely election is always required. Corporate classification may be beneficial to foreign investors concerned about U.S. estate and gift tax issues.

 

Concluding Advice

 

There are specialized FIRPTA tax issues for U.S. real estate transactions involving a buying or a selling LLC. Buyers of U.S. real estate should make sure to receive a reliable exemption certification, otherwise withhold a sufficient amount of the purchase price and comply with the I.R.S. requirements.  Agents who may have knowledge that a seller’s exemption certification is false, should provide written notice to the buyer.

Douglas J. Kingston is an Arizona certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be reached by:

Telephone: (602) 595-5885E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/