A person who is not a citizen of the United States and does not meet either the green card test or the substantial presence test of income tax residency is considered a nonresident for U.S. federal income tax purposes. While U.S. citizens and tax residents are subject to U.S. taxation on their worldwide income, nonresidents are generally subject to U.S. taxation only on certain U.S. source income.
Rental income derived by a nonresident from U.S. real estate is U.S. source income. It is generally subject to U.S. income tax at a flat 30% tax rate on gross rents with no deduction for rental expenses, unless the so-called “Net Election” is made. In this case, the net U.S. rental income received after expenses by a nonresident will be taxed at graduated tax rates up to 39.6%. Capital gain income derived from a disposition of a U.S. real property by a nonresident will generally be taxed at capital gain tax rates of either 15% or 20%.
Under FIRPTA, the enforcement mechanism contemplated for collecting the capital gains tax from the sale of U.S. real property by a nonresident requires that on a disposition of U.S. real property, the transferee (usually the buyer/buyer’s agent) must withhold 10% of the total amount realized by the nonresident (“FIRPTA withholding”), unless one of the few exemptions applies, such as the sales price being less than $300,000. The 10% withholding tax is remitted by the buyer or buyer’s agent to the IRS.
In some instances, a nonresident’s final tax liability may be less than the amount withheld under FIRPTA. While any FIRPTA withholding that is in excess of the nonresident’s final tax liability will be refunded to the nonresident when his/her tax return is filed, the nonresident can, if he/she so desires, apply for a “withholding certificate” from the IRS requesting a reduced amount withholding. This is done by filing Form 8288-B (Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests). Such form must provide a calculation of the maximum tax liability that may be imposed on the disposition of the property and should be sent to the IRS after a contract is signed on the property, but before the settlement date. A copy of the 8288-B is provided to the buyer/buyer’s agent, allowing him or her to retain the funds until he/she receives an approval letter from the IRS to remit any of the excess withholding tax back to the nonresident seller.
The IRS has indicated that the average time frame for processing an 8288-B application is approximately 3 months. Therefore, it is typically wise from a cash flow perspective for a nonresident seller of U.S. real property to apply for an 8288-B withholding certificate if the sale takes place early in the year to early autumn since he/she will then likely receive a refund of the FIRPTA withholding before the end of the year. If the sale takes place from mid-October through December 31, it is better for the nonresident to wait and file for a refund claim of the FIRPTA withholding by filing a tax return for that year.
Our International Tax Director, Dale Mason, discusses this topic in the following video:
Want to read more about it? Read our article on Taxation of Nonresidents’ Investment in U.S. Residential Real Estate
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To find out whether you are a nonresident, watch this video: