Tax Loophole Plugged in Foreign-Owner Sales

The Internal Revenue Service has plugged a loophole involving foreign ownership of real estate in the United States.

Since Jan. 1, an amendment to the Foreign Investment in Real Property Tax Act made it necessary for people buying property from foreigners to set aside 10% of the purchase price for the Internal Revenue Service.

If the 10% is not withheld, buyers and brokers are liable to the IRS.

As Jerry Asher, senior vice president and regional manager of Coldwell Banker, explained: “It’s critically important for all brokers--commercial and residential--to be aware of the provisions because the brokers can now become personally liable for monies not reported.” An agent’s liability is limited to his or her commission, and the buyer would be required to pay the tax owed and interest on the tax.

The amendment provides that every buyer of real estate in this country must withhold 10% of the sales price unless an exemption is obtained from the IRS in advance or the buyer obtains an affidavit executed by the seller under penalty of perjury stating that the seller is not a foreigner. If a property is co-owned, every co-owner must sign an affidavit to exempt his or her interest from withholding.

The amendment also stipulates that buyers and agents involved in a sale should conduct an investigation to determine that the selling parties signing non-foreign person affidavits are the true owners of the real property interest being conveyed. Actions by an owner to “domesticate” the title (through double escrows, straw men or conveyances before the closing of escrow) to conceal ownership by foreign persons, will be construed as tax evasion by the IRS.

If the cash portion of the purchase price to be paid before close of escrow is not large enough to cover the 10%, the buyer must still withhold the full 10% unless the seller obtains from the I RS a “qualifying statement” permitting some other withholding arrangement. The only type of real property that is exempt from withholding is residential property having a price not greater than $300,000 purchased by the buyer for use as the buyer’s residence.

The reason for the amendment was to “simplify the procedure,” according to Lowell Langers of the IRS’s Los Angeles public affairs office. Previously, she said, there were “involved reporting requirements.”

Los Angeles attorney Richard F. Davis, a partner in the real estate department of Memel, Jacobs, Pierno & Gersh, said, “The requirements were confusing, and they were difficult to enforce. It was difficult to convince owners to make all of the revelations required.”

In the winter issue of the Realtors National Marketing Institute’s Commercial Investment Journal, Davis wrote that the Foreign Investment in Real Property Tax Act “sought to enforce payment not through withholding, but rather by requiring comprehensive reporting of foreign ownership of U. S. real property by means of annual information returns that required identification of the names and addresses of ultimate beneficial owners.”

The amendment that became effective this month “gave teeth” to the law while “eliminating the need to get all that information,” he told The Times.

“Withholding is simple,” he said. “It just imposes an obligation to withhold a certain amount once the money is in the pot.”

The act was originally conceived, he explained in his article, to “remove the pre-existing exemption from U. S. taxation of any gain on the sale of U. S. real estate, which was previously available to foreign investors but not to domestic investors.”

However, he said in a telephone interview, there were ways to “get around these requirements,” and even now, he conceded, “there are ways to set up a legal structure that would allow a transfer of some ownership rights indirectly without having them subject to taxation.” However, he added, “these are very complicated and would only be applicable in certain cases.”

Essentially, the difference before the amendment and now is this, he said: “People were structuring deals to avoid tax. Now they are structuring to minimize tax.”

Besides the withholding provision, the amendment also overrides treaties with foreign governments allowing foreigners to avoid paying capital gains taxes on real property in the United States when the property is sold.

“So there is no advantage in holding a property through the Netherlands Antilles or another foreign entity except with income- producing properties, because the income may still be subject to some treaty benefits,” he said.

Even so, he contends that the amendment “puts the foreign investor on a parity with the domestic investor.” After all, he said, “if you and I went to the same foreign countries and were able to buy and sell real property there, they would tax us. There is no reciprocity.”

Davis does not foresee any negative impact on foreign investment in the United States as a result of the amendment “because we are one of the few countries where a foreigner can walk in and buy real estate, and there is a low political risk here and a stable economy. The benefits outweigh the detriment of paying the same tax that the citizens here have to pay.”

However, there are some concerns about the act even on Capitol Hill. “Sen. (Barry) Goldwater (R-Ariz.) has suggested that the whole thing be repealed,” the IRS’s Langers said.

And there is at least one controversial aspect of the amendment. As Langers explained it: “Withholding is on the amount realized rather than the gain, so the withholding could be more than is owed.”

This could be remedied by applying for a refund, she said, “but this is so new, I’m not sure how fast it would be handled.”

She is sure of one thing, though: “There will be comment on this from all quarters.”