Winter Park Home Magazine - Issue 3 - 2009
SURPRISE! A Hidden Federal Lien
by Frank L. Pohl, Attorney At Law
Partner, Pohl & Short, P.A., Winter Park
There is a significant hidden federal tax lien that may attach to real property conveyed by a foreign Seller which may not be evidenced by a search of the public records, and which may impose an obligation on the Buyer to pay a portion of the Seller's income tax obligation.
Congress passed the Foreign Investment in Real Property Tax Act ("FIRPTA") in 1980. This law was enacted to enable the federal government to collect income taxes on transfers of real property situated in the United States by foreign individuals. Foreign nationals were routinely collecting proceeds from a sale, and not reporting the income/profit generated by the sale of that property. Under FIRPTA, the Seller is obligated to pay 10% of the gross sales price to the Internal Revenue Service, unless the Seller can provide proof that no taxes or a lesser amount are owed on the transfer. The Act furthermore provides that if the 10% is not paid, or otherwise satisfactorily addressed, that a lien for 10% of the sales price automatically attaches to the real property purchased by a Buyer. As a result, a Buyer could be obligated to pay the IRS 10% of the gross sales price of the property.
Consider the following example. Patrick Irish, a citizen of Ireland, owns real property in Florida. Mr. Irish and Joe Buyer enter into a Purchase and Sale Agreement for a purchase price of $1,000,000.00. Mr. Buyer obtains a title search on the property, and determines that there are no recorded liens against the Seller. In an attempt to save closing costs, Mr. Irish and Mr. Buyer dispense with obtaining a title insurance policy, and independently prepare the Warranty Deed and conduct a closing without the services of legal counsel or a title insurance underwriter. The format and execution of the deed conform with Florida law. The deed is recorded, and all documentary stamps and real estate property taxes are paid. Six months later, Joe Buyer receives a letter from the Internal Revenue Service assessing him $100,000.00 for the transfer from the Seller. Mr. Buyer of course now seeks legal counsel and asks "what is this letter about?" Due to FIRPTA, Mr. Buyer learns that he may now have to pay the IRS $100,000.00.
In a typical real estate closing, the Seller signs an Owner's Affidavit that establishes, among other issues, whether the Seller is a foreign individual as defined under FIRPTA. It is standard conveyancing practice, when the Seller is a foreign individual (which includes foreign corporations and other legal entities), for the closing agent to complete and submit the relevant FIRPTA forms, together with 10% of the gross sales price, to the IRS' FIRPTA Unit - all within 20 days of closing. This 10% must be submitted even if the settlement statement reflects that the Seller did not receive any money from the closing - if there are insufficient funds the Seller must come "out of pocket" to pay this 10% obligation, or the closing cannot be completed. The Seller may also reduce or eliminate that payment obligation if it timely files a withholding certificate with the Internal Revenue Service to establish that no taxes, or a reduced amount of taxes, are owed. None of this of course was done by Mr. Irish, and as a result Joe now owes the IRS $100,000.00, or must otherwise justify to the IRS why that money is not owed. Joe can of course seek reimbursement from the Seller. The outcome of that request, unfortunately, is very predictable.
Currently there exists one exemption under FIRPTA for payment of this 10% obligation by the foreign Seller. This exemption applies when the gross sales price is under $300,000.00, the property is residential in use, and the Buyer signs an affidavit reciting that he (and his relatives) will live on the premises more than 50% of the number of days (excluding days the property is vacant) that the property is used by any persons for residential purposes during each of the two years following the purchase. Sometimes these affidavits are executed in a spirit of cooperation with the Seller, without the underlying requisite intent to reside on the property for the stated time periods. If the affidavit is fraudulent, the tax obligation will attach to the real property, together with any penalties for fraud, and the Buyer will then be obligated to pay taxes it may not otherwise have been obligated to pay if it had not signed the affidavit. If there is any question as to the validity of the statements in this Buyer's affidavit, the Buyer clearly should not execute this document.
In addition to the typical arms-length sale of property by a foreign Seller, there are other events which may trigger the application of this FIRPTA obligation. For example, a foreign corporation may decide to distribute real property to one of its shareholders. Technically no money is paid. However the IRS may treat this as a taxable transfer, and if 10% of the gross property value is not paid to the FIRPTA unit, the shareholder/transferee may not only be obligated to pay the transfer tax for the conveyance from the corporation, but that same shareholder, if a foreign citizen, may also have to pay taxes a second time when selling the property at a later date.
Whenever real property is transferred by a foreign individual or entity, the transferor should always protect its financial interests by consulting with its legal counsel and/or accountant before proceeding with the conveyance. The purchaser, on the other hand, should ascertain through his legal counsel that the FIRPTA rules have been satisfied, and that this potential hidden lien will not attach to the property that he is purchasing.
