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  • Writer's pictureBrad Konishi, CPA

FIRPTA and 1031 Exchange

There are a number of really good reasons to do a 1031 exchange - chief among them, the tax deferral that one would get as a result of doing a valid 1031. When a 1031 is being done by a foreign person, however, that transaction may still be subject to FIRPTA withholding, but doesn't necessarily need to be if you plan your transaction correctly.

(caveat: the information presented is complex - see a qualified tax professional for more information)

FIRPTA is a federal withholding of up to 15% of the gross sales price of real estate owned by a "foreign person". When a foreign person is doing a proper 1031 exchange, HARPTA may be waived immediately using Form N-289 which the seller will obtain from their escrow officer once they go into contract (when they accept an offer), but FIRPTA will be withheld unless the seller obtains a "withholding certificate" from the Internal Revenue Service. Here are the requirements:

  1. If the exchange is simultaneous with no "boot" (which includes debt relief), then the buyer generally will accept a "FIRPTA Notice of Non-Recognition Transfer" and no FIRPTA is withheld. However, simultaneous exchanges are far less common than deferred exchanges. If you can't do a simultaneous exchange, the following 2 points will apply:

  2. The seller/exchanger would need to submit a Form 8288-B to the IRS prior to the close date. That form must be submitted to the IRS along with a contract for the purchase of a replacement property. Once submitted, the IRS has 90 days to render a decision (in theory, as covid has negatively impacted processing times). The one thing that often trips up a seller/exchanger is that they don't have a replacement property in contract yet when the soon-to-be relinquished property goes into contract.

  3. Keep in mind that if the replacement property closes before the IRS renders a decision on your 8288-B, the seller/exchanger may receive cash. For example, let's say a relinquished property sells for $1,000,000, but because of the FIRPTA withholding of 15% (equal to $150,000), the seller would only have $850,000 ($1,000,000 less $150,000 FIRPTA withheld). Then when the IRS does render a decision and money is sent back to the seller/exchanger, it may become taxable at that point. The seller/exchanger might be able to get around this if they deposit $150,000 with the settlement agent prior to the close of the relinquished property.

We help clients file for early refunds, so when prospective clients ask us to help them get a FIRPTA waiver or early refund, we need to find out from them if they're close to identifying a replacement property. This is key to obtaining an early refund during a deferred 1031 exchange.

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