U.S. Congress was busy at the end of the year. There was much debate about several key pieces of legislation that have the potential to affect Canadians in 2016, including the popular EB-5 investment-for-visa program, which I most recently blogged about here. Amid the flurry of activity, President Obama signed a key piece of legislation into place: the Protecting Americans from Tax Hikes Act of 2015 (“PATH”).
PATH makes important changes to the Foreign Investment in Real Property Tax Act (“FIRPTA”) by increasing the amount of withholding due on the sale of U.S. real property by foreigners in certain circumstances. First, I’ll explain FIRPTA and how it has affected Canadian owners of U.S. property until now, and then I’ll explain how PATH affects FIRPTA.
FIRPTA Until Now
Under FIRPTA, the default rule has been that 10% of the gross sales price of U.S. real estate by a non-resident of the U.S. must be withheld by the transaction’s closing agent and remitted to the IRS upon sale.
Note that the amount withheld is not a tax; the IRS applies the withholding against any capital gains tax owing on the sale. So if the withheld amount exceeds the amount of capital gains tax due when a non-resident files his or her U.S. income tax return, the IRS will refund the difference.
There is an important exception to the withholding rule: where the gross sales price is less than $300,000 and the buyer signs an affidavit attesting to the fact that he or she intends to use the property over the next two years for personal use at least 50% of the time that the property will be used, the transaction’s closing agent does not need to submit the withholding to the IRS on behalf of the foreign seller.
The Impact of PATH on FIRPTA
Under PATH, the above-described FIRPTA exemption is still in place for personal-use properties sold for less than $300,000. However, when FIRPTA applies, the default rate for the amount of withholding has changed: for properties with a gross sales price under $1 million, the withholding rate remains 10%, but for properties with a gross sales price over $1 million, the withholding rate is now 15% of the gross sales price.
Additional Changes Implemented by PATH
In part, PATH aims to stimulate the U.S. economy by making foreign investment in U.S. real estate more attractive. One way the legislation accomplishes this goal is by revising FIRPTA’s application to foreign pension funds: as a result of PATH, certain foreign pension funds are now exempt from FIRPTA when they dispose of U.S. real property. This change will positively impact Canadian pension funds, which frequently invest in commercial U.S. real estate.
PATH also makes some of the rules surrounding the taxation of real estate investment trusts, or REITs, more favourable. I’ll provide more information about these changes in a future blog.
In the meantime, if you have questions about PATH or FIRPTA, contact me at firstname.lastname@example.org. Or, if you’re a Canadian who owns property in the U.S., request a consultation with me or one of our other cross-border attorneys. We would be pleased to advise you on the strategies available to minimize the impact of FIRPTA withholding as recently changed by PATH.