Foreign Sellers of US Real Estate: Understanding Federal and California Withholding Rules
Real Estate Withholding Rules for Foreign Sellers
When a foreign person sells real estate located in the United States, special tax withholding rules apply at both the federal and state levels. These rules often surprise sellers and buyers alike because the tax is withheld at closing based on the gross sales price rather than the actual gain. Understanding how these rules work in advance can prevent cash flow surprises and compliance issues during escrow.
Federal Withholding Under FIRPTA
The Foreign Investment in Real Property Tax Act, commonly referred to as FIRPTA, requires buyers of US real property to withhold federal tax when the seller is a foreign person. Under Internal Revenue Code Section 1445, the buyer must generally withhold fifteen percent of the amount realized, which is typically the gross sales price.
The buyer is legally responsible for this withholding. If the buyer fails to withhold and remit the tax, the Internal Revenue Service can hold the buyer liable for the unpaid amount. FIRPTA withholding is not the final tax. It is a prepayment that the foreign seller later reconciles on a US income tax return.
In situations where the actual tax due on the sale will be less than the required withholding, the seller can apply for a withholding certificate using Form 8288 B. If approved, this certificate allows the withholding amount to be reduced to more closely match the expected tax liability.
California Real Estate Withholding
California imposes its own withholding requirements when real property is sold by a nonresident seller, including foreign individuals and entities. This withholding is separate from FIRPTA and applies even if federal withholding is already required.
In most cases, California withholding equals three point three three percent of the total sales price. This amount is reported and remitted using Form 593 at the time of closing. As an alternative, sellers may elect a gain based calculation that applies the highest applicable California tax rate to the estimated gain from the sale.
Certain exemptions exist, including low value transactions and qualifying like kind exchanges, but these exemptions must be properly documented during escrow. Without proper documentation, withholding is generally required.
Buyer and Escrow Responsibilities
Both federal and California withholding regimes place significant responsibility on the buyer and the escrow or closing agent. At the federal level, FIRPTA withholding is reported and paid using Forms 8288 and 8288 A. At the state level, California withholding is handled through Form 593.
These obligations exist regardless of whether the buyer is aware of the seller’s tax status. Proper due diligence during escrow is critical to ensure compliance and avoid penalties.
How Federal and State Withholding Work Together
Federal FIRPTA withholding and California real estate withholding operate independently. In many transactions involving foreign sellers of California real estate, both withholdings apply. Amounts withheld are later claimed as credits on the seller’s federal and California income tax returns.
- Federal withholding is generally fifteen percent of the gross sales price.
- California withholding is generally three point three three percent of the sales price or an alternative gain based amount.
- Both are prepayments, not final taxes.
- Failure to withhold can create liability for the buyer.
Final Takeaway
Selling US real estate as a foreign person involves more than negotiating a sales price. Federal and California withholding rules can significantly affect cash received at closing and must be planned for in advance. With proper structuring and timely filings, withholding can often be reduced to reflect the actual tax owed rather than the default percentages.
