Under a new law that took effect Jan. 1, home buyers may be held liable for the seller's taxes on the transaction if the seller is a foreigner and does not pay them himself.
The new provision, part of the 1984 tax act passed last summer, requires the buyer to determine if the seller is a foreigner and, if he is, to withhold 10 percent of the purchase price. The buyer must turn this money over to the IRS within 10 days and file a special new reporting form.
If the buyer fails to comply, he may become liable for the full 10 percent that he should have withheld as well as up to $10,000 in additional penalties.
If the American buyer doesn't know the seller is a foreigner or a foreign corporation -- or otherwise fails to withhold the money from the transaction price -- that's too bad, says the IRS. He is still liable for the seller's capital gains tax if it is unpaid, and is subject to the additional penalties.
"What this new law means is that the buyer in any real estate transaction should find out if the seller is a foreigner," said Henry Miller, a D.C. tax lawyer. "Uncle Sam wants to get his share before the foreigner leaves the country . . . and the buyer better cover himself or he could get caught in the middle."
The IRS said it expects to collect an estimated $85 million in additional revenue in the next five years as a result of the new law.
There are a number of exemptions in the law, but its scope is wide enough to have real estate brokers and agents across the United States nervous. They can easily imagine an American buyer who unwittingly failed to comply and got hit with extra taxes suing his agent for damages.
Agents and brokers have a fiduciary duty to the buyers that a court might interpret as including a duty to disclose the potential liability.
"The law has a lot of bite," said Mark K. Grasse, an IRS agent with the foreign operations district. "We've also been hearing a lot of confusion about it. A lot of people here with the IRS don't know about it, and we didn't even have the filing forms ready when it went into effect."
The withholding requirement does not apply if the property costs less than $300,000 and the American buyer intends to live in it for two years. If the property costs more than $300,000 or is bought as investment property -- residential or commercial -- the law does apply.
If the seller is a foreigner but claims that he is not required to pay capital gains tax because of a nonrecognition provision between his country and the United States, then the seller must protect himself by getting an affidavit to that effect signed under penalties of perjury. The buyer and seller cannot be related in such a case, and the buyer cannot accept such an affidavit if he knows, or should have reason to know, that the nonrecognition provision does not apply to the seller.
Because not all foreigners' tax liability is as much as 10 percent, the IRS allows those who expect to pay less to obtain a withholding certificate to that effect. The certificate would state either that the buyer had to withhold a lesser amount -- possibly nothing -- or that the foreigner had made other arrangements with the IRS to cover his tax liability. The IRS is required to act on a request for a withholding certificate within 90 days.
The law applies not only to residential and commercial real property but also to shares in real estate property holding companies, unless the company is publicly traded in the United States.
Congress first passed what is known as the Foreign Investment in Real Property Tax Act in 1980 in an effort to track down capital gains by foreigners investing in and selling U.S. real estate. The 1980 law authorized the IRS to write regulations that would have required foreigners to register their real estate holdings.
After years of struggling with the reporting regulations -- and foreign investors unwilling to register their U.S. holdings -- the IRS returned to Congress last summer with the proposal to shift the liability burden to the American buyer.
"This provision is clearer and administratively easier to work with," said Miller. "It means that in case the foreigner leaves, the IRS has someone to go after. The property is still there and someone owns it -- someone the IRS can visit."
Americans can protect themselves against the liability by getting the seller to sign a document that states he is a U.S. taxpayer, either a citizen or resident alien. But they can't do that if they don't know the law exists.
A spokesman for the National Association of Realtors said that his organization had alerted brokers and is providing sample affidavits. Some local Realtor boards are considering including a line in their standard sales contract that says, "I am a U.S. taxpaying citizen or resident alien." When the seller signed the contract, the buyer would be covered automatically.
"We are educating our members about it and suggesting they get an affidavit of disclosure from every seller, whether they suspect the seller is a foreigner or not," said David Strachen, executive vice president of the Washington Board of Realtors. "If the seller says he is a taxpaying U.S. citizen, we're telling the buyer to get that on a signed affidavit."
Grasse said the buyer may use whatever criteria he wants to determine if the seller is a foreigner or not, but he suggested that asking for the affidavit should become standard real estate practice.
The law includes a provision that holds real estate brokers and agents liable up to the amount of their fee on the transaction if they knew, or had reason to know, that a foreigner had signed an affidavit fraudulantly saying he was a U.S. taxpaying citizen.
Brokers and agents in Washington say they do not mind the new law so much, because the responsibility is relatively easy to live with, but they are concerned that they could lose sales if it comes up at the last minute, such as at the settlement table.
"If foreigners didn't want to register their properties before, they probably won't be thrilled when a buyer surprises them with 10 percent withholding at the settlement table," said Dan Richard, a former D.C. real estate agent who now writes a real estate marketing newsletter. "These rules could kill some deals."
Grasse said that, in cases when the law does apply and the buyer is required to withhold the 10 percent, it doesn't matter if there is no cash out of the sale.
"It's 10 percent of the purchase price, not the cash," said Grasse. "If it is a deal where they don't get any money out, they better find a way to come up with the 10 percent real quick."
The money withheld is required to be sent to the IRS -- postmarked no later than 10 days after closing -- along with filing form 8288. If the buyer is required to withhold and doesn't, the IRS may collect the tax and any penalties -- which could range up to $10,000 -- through a property lien if necessary. If the buyer withholds the money but doesn't send it to the IRS within 10 days, he could face criminal penalties.
The new law is not expected to affect the largest foreign investors in U.S. real estate, however, because most of those companies already are buying and selling through U.S. subsidiaries that pay U.S. taxes.
"I don't think it will have much effect on the commercial real estate market, or even that it will cause many significant problems," said Kent Jones, chief financial officer for client accounts with Richard Ellis Inc., an international real estate consulting firm in New York. "It will mostly just complicate transactions a bit, but it's not nearly as burdensome as the proposed reporting requirements would have been."