There was a time when non-citizens were allowed to own and sell U.S. real estate and not have to worry about paying any sales tax. The lack of tax made U.S. property an appealing investment opportunity. Everything changed in 1980 when the Foreign Investment in Real Property Tax Act (FIRPTA) of 1980 went into effect. While this didn’t prohibit investors from other countries from purchasing and selling U.S. property, it did ensure that the U.S. government received their fair share of the transactions.
The result of FIRPTA is that when a non-U.S. property owner decides to sell a U.S. property they own, the person who purchases the land must pay the IRS 15% of the gross sale price. If the property is sold for $300,000 and $1,000,000 and is destined to become the buyer’s residence, the IRS only requires 10%. FIRPTA is unique in that it requires the buyer, not the seller, to handle the additional tax. Once they’ve sold the property, the foreign seller is able to claim a tax credit for the property. The seller will be awarded a refund if their tax liability is less than the amount they sold the property for.
During 2017, a total of 17,382 foreign sellers filed tax returns that amounted to $598.7 million in FIRPTA credits.
In 2016, the government decided it was time to take a look at the FIRPTA and made some changes. These changes were accepted and most people forgot all about FIRPTA. Until recently. It turns out that there are some costly discrepancies in the FIRPTA. Everyone wants to know if these discrepancies are being addressed, and if they are, how will they impact current and future property sales.
How the FIRPTA Discrepancies Were Discovered in IRS Form 8288
Problems with FIRPTA were discovered in the same manner that most tax discrepancies are found, via an audit. The audit was conducted by the Treasury Inspector General for Tax Administration (TIGTA.) The reason for the audit was clearly stated in the TIGTA’s final report.
“The overall objective of this review was to assess IRS efforts to verify the accuracy of withholding credits reported on Forms 1040NR and Forms 1120-F.” – Final report on the FIRPTA audit, published March 9, 2020.
What the TIGTA Learned From Auditing FIRPTA
For the audit, the TIGTA looked at the 2017 tax year. They found that nearly 3,000 of the buyers who purchased a property from foreign sellers had discrepancies on their returns. The discrepancies added up to an excess of $688 million. Reasons for the discrepancies included:
- Unclear guidelines
- IRS employee errors
- Incorrect guidelines
Another problem the TIGTA discovered during the audit was that the IRS failed to have all the necessary procedures in place which were needed for the IRS to double-check the Withholding Certificates and make sure the proper amount was assessed to buyers’ tax accounts. By the end of the audit, the TIGTA identified 3,184 Forms 8288 that hadn’t been properly assessed by the IRS. They also found that buyers failed to accurately report about $22 million to the IRS. They also found that mistakes were made in the seller’s benefits, mistakes that added up to about $60 million.
Changes Recommended by TIGTA Regarding FIRPTA
Based on the results of the audit, the TIGTA made 12 different recommendations that should help the FIRPTA operate more efficiently.
Failure to properly process the paperwork connected to FIRPTA is a serious problem within the IRS. The improperly processed paperwork creates problems for buyers, sellers, and the IRS. To resolve this particular problem, the TIGTA recommends:
- Taking the time to make sure duplicate Form 8288-A haven’t been accidentally entered into the system
- Making sure that the buyers understand that following the joint purchase of a property, that both buyers file a separate Form 8288-A
- Making sure that the buyer submitted the total amount of the taxes owed for the property when they turned in the Form 8288
To decrease the number of filing mistakes, TIGTA recommends:
- Creating a system that streamlines and improves the overall efficiency of processing
- Creating a training program so each employee understand exactly what steps to take to make sure the information on a property sale impacted by FIRPTA is properly processed
- Reviewing the buyers who created a discrepancy when they filed their Review the 2,988 buyers we identified with a discrepancy between the withholding reported on Form 8288 and the withholding reported on the associated Form 8288-Aand correct the withholding recorded
From 2017-2018 a total of 26,363 were identified that the IRS failed to properly assess. The total of these unassessed forms came to $264 million. Mistakes connected to these incorrect withholdings include:
- Failure to file the Withholding Certificate on time
- Incomplete forms that weren’t corrected
- Processing problems
The recommended solutions include:
- Creating a program/process that enables the tax examiners to go over each form and make the proper amount is assessed.
- Creating a program that confirms that each of the tax examiners connected to FIRPTA knows how to properly process and assess the amount connected to the property and makes sure the correct withholding tax has been paid.
- Taking time to make sure that the 2,268 Forms 8288 that weren’t handled properly are identified
TIGTA Discovered the Buyers Had Over Paid
The TIGTA inspected 17,382 Forms 1040NR and Forms 1120-F14 that were filed during 2017 and found that 1,835 had returns that involved an IRS employee error. TIGTA believes that the cumulation of these errors resulted in approximately $60 million in withholding credits that the filers failed to receive from the IRS. For this problem, the recommendation involves reviewing the cases were the withholding credit was not received and take appropriate action to recover the missing funds.
Buyers Failed to File IRS form 8288 With the IRS
The IRS has failed to set up a third-party system to review land sales and identify buyers who failed to file the paperwork and pay the taxes connected to the property they purchased. The recommendation to correct this oversight is setting up a system that identifies which properties have been sold and which buyers failed to report and pay within the required timeline.
The IRS has agreed with most of these recommendations and plans to put them into action.