U.S. Tax Services

The Sale of U.S. Real Property

Facts and Assumptions

1. Client is a resident of Canada and is a non-US person.  He/She owns a vacation home (the “Property”) in the state of Arizona which was purchased for $800,000 in September, 2011.  The property was purchased from the Estates of Beverly B. Brinckerhoff and H. Todd Brinckerhoff (“the Estates”), whose post office address, at that time, was 7 east 85th Street, Apartment #7D, New York, NY 10028.  It appears that both Estates are U.S. resident estates. The property was purchased strictly for personal use and was never rented out.

2. The Property will be sold for $1,493,000 (with an anticipated closing date of April 27, 2016). The resulting capital gain from the sale of the Property is projected to be $693,000.  The maximum capital gains tax on long-term gains (i.e. held more than 12 months) in the US is currently at 20%.

3. Our client was issued an Individual Taxpayer Identification Number (“ITIN”) in June, 2011 and filed a 2010 US Form 1040-NR to claim a refund for the US tax that was withheld on her original purchase of the Property. The client has not filed a US tax return for any of the taxation years from 2011 to 2014.

Procedure for ITIN Application and Renewal

1. The Protecting Americans from Tax Hikes Act of 2015 (“PATH”) was passed in December, 2015, which, inter alia, modifies certain rules related to the ITIN application procedures and adds other rules regarding the term of existing and new ITINs. One such modification is that ITINs issued in 2011 are set to expire on the earlier of the last day of the 3rd consecutive year that a US tax return was not filed or January 1, 2020.  Therefore, in Linda’s case, her ITIN expired at the end of 2013 and would need to be renewed before January 1, 2020. 

2. Given that the changes under the PATH Act were just recently enacted, the Internal Revenue Service (“IRS”) has yet to issue guidance on the ITIN renewal procedures.  In a recent email to Acceptance Agents by an ITIN Manager from the ITIN Policy Section, the Manager advised, via email, that “…we are still evaluating the changes required to implement the PATH Act Legislation.  Further details will be posted on IRS.gov in the coming months.  Until then, ITINs will continue to be issued and accepted using existing policies and procedures.”  This email however was retracted shortly after its release.  I have contacted the IRS February 8, 2016 and was advised by an IRS International Agent in the ITIN Section that existing ITINs can be used; therefore, until further guidance is issued, Linda’s existing ITIN can be used for tax reporting purposes.

Withholding Tax on the Gross Proceeds from the Sale of U.S. Real Property ("USRP")

1. Effective for USRP dispositions after February 16, 2016, under the PATH Act, the buyer is required to withhold from the seller an amount equal to 15% of the gross proceeds of the purchase price (regardless of the actual US tax liability).  The rate is reduced to 10% if the property is purchased for use as a residence by the buyer (or member/s of his family) where the purchase price does not exceed $1,000,000.  There is an exemption from withholding tax if the property is acquired by the buyer for use as a residence and the purchase price is not more than $300,000.  Prior to the PATH Act, the required withholding was 10% and the $300,000 residence exception was in already in place.

2. In Linda’s case, the buyer will be required to withhold 15% of the gross proceeds which is equivalent to $223,950 ($1,493,000 x 15%).  However, Linda or the buyer can request the IRS to determine a reduced withholding equivalent to the maximum tax liability.  The maximum tax liability is equal to the sum of the maximum amount of US tax that could be imposed with respect to the disposition of the Property plus the amount the IRS determines to be Linda’s unsatisfied withholding liability with respect to when she purchased the Property from the Estates. 

To illustrate, Linda’s maximum tax liability on a capital gain of $693,000 is $138,600 ($693,000 x 20%) which is $85,350 less than the 15% mandatory withholding on the gross purchase, as discussed above.  Assuming that, back on December 30, 2010, Linda originally purchased the Property from a foreign person (i.e. non-US citizen, resident, trust, estate or entity), and she failed to withhold the mandatory 10% withholding tax on gross proceeds of $800,000, the IRS will add this mandatory 10% withholding of $80,000 ($800,000 x 10%) to the maximum tax liability for a total of $218,600 ($138,600 + $80,000).  However, since the Property was purchased from what appears to be a US estate, Linda was not obligated to withhold 10% of gross proceeds at the time that she first acquired the Property.  Her maximum tax liability would, therefore, be limited to $138,600.  Note that it would have been prudent if Linda had requested a certification of non-foreign status at that time from the executors of the Estates, as this will constitute proof to the IRS on the subsequent sale of the Property, that the Property was purchased from a US (i.e. non-foreign) person.

3. In summary, Linda has the following options:

    Option 1: Withhold and Remit 15% to the IRS

  1. a. Linda will complete, sign and submit a certification to George and Linda Rose or their escrow agent (collectively referred to as “the Buyer”) that she is a “foreign person”.  Linda will also submit her ITIN to the Buyer.

  2. b. The Buyer will then withhold and remit the 15% withholding tax to the IRS together with Form 8288 “U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests” and Form 8288-A “Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests”.  These forms will be completed by the Buyer.  Form 8288-A reports the gross proceeds, the transfer date and the withholding tax.  Form 8288 is the form that “transmits” the Form 8288-A to the IRS.

  3. c. Upon receipt, the IRS will “stamp” Copy B of Form 8288-A and will forward the “stamped” copy to Linda.  Linda will file a 2016 U.S. tax return by June 15, 2017, and will attach the “stamped” Form 8288-A to the 2016 U.S. tax return in order to request for a refund of any excess withholding tax.  

  •     Option 2, Request for Reduced Withholding with the IRS

    1. a. Linda will complete, sign, and submit a certification to the Buyer that she is a “foreign person”.  Linda will also submit her ITIN to the Buyer.

    2. b. Linda (or the Buyer) will apply to the IRS for reduced withholding on Form 8288-B “Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests”.  Linda’s and the Buyer’s ITIN (or US social security numbers of George and Linda Rose) have to be reported on the application.  The application including a calculation of the capital gain and supporting documents must be submitted to the IRS on or before the closing date or date of transfer.  Also, to be included with the application is proof that Linda has purchased the Property from the Estates and, therefore, had no withholding obligation with respect to the purchase from a US person.  Absent a completed and signed certification of non-foreign status from the executors of the Estates at the time of purchase, Linda will have to provide satisfactory evidence to the IRS that the Estates is a US person. Satisfactory evidence can be a combination of a copy of the Bill of Sale, Absolute, Settlement Statement and a written statement from the executors of the  Estates certifying its status as a US Estate (i.e. non-foreign) at the time of purchase and that the Estates had sold the Property to Linda.

    3. c. The Buyer will withhold 15% of gross proceeds which will be retained in an escrow account pending the receipt of the Certificate of Reduced Withholding from the IRS.

    4. d. The IRS will determine the maximum tax liability and, if satisfied with the documentation submitted with the Form 8288-B, will issue a Certificate of Reduced Withholding to Linda authorizing a reduced withholding of approximately $139,000 (note that the IRS may arrive at a different number).  The IRS is required to act on the application within 90 days after it receives it. 

    5. e. Linda will forward a copy of the Certificate of Reduced Withholding to the Buyer in order for the Buyer to remit the $139,000 to the IRS and release the balance of approximately $85,000 (15% withholding of $224,000 (rounded) less $139,000, which is the projected capital gains tax liability) to Linda.  The Buyer will have 20 days to remit the $139,000 to the IRS together with Forms 8288 and 8288-A as described above.  The same process applies under Step c of Option 1 above.

    6. f. If the application is denied, the IRS will notify Linda in writing.  Linda will inform the Buyer of the denial, upon which the Buyer will have 20 days to remit the entire taxes withheld to the IRS together with Forms 8288 and 8288-A.  The same process applies under Step c of Option 1, as above, if this occurs.  Linda can only file a claim of refund by filing her 2016 U.S. tax return by June 15, 2017.

    7. g. Upon receipt of the “stamped” Copy B of Form 8288-A from the IRS, Linda can request in writing for an early refund with the IRS if she wishes to receive her refund before filing the 2016 US tax return.  Linda will still be required to file a 2016 U.S. tax return by June 15, 2017. 
  • Our opinion is that Option 1 would be the simplest and most straightforward process that carries with it a lesser chance of error and scrutiny by the IRS.  However, Linda will have to wait until 2017 to file a claim for refund.

    Under Option 2, Linda will have the ability to recover part of the 15% withholding tax much earlier but the application on Form 8288-B is not without its challenges and carries with it the risk that the IRS may deny the application.  Without the proper certification of a non-foreign affidavit from the executor of the Estates, Linda will have to be able to provide convincing evidence that is satisfactory to the IRS.  The information submitted may be subject to verification by the IRS prior to the issuance of the withholding certificate which may further delay the process.  In addition, unless George and Rebecca Rose engage a competent escrow agent or lawyer that is well-versed in withholding obligations to non-residents of the U.S., there is a risk that the appropriate forms and filing procedures would not be completed correctly and accurately. However, the process is still feasible and can be successful if executed properly from the outset.  Linda will still be required to file a 2016 US tax return in 2017.

    For more information on this or other programs please contact one of our U.S. Tax Professionals.

     

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