Does the 10 percent FIRPTA rate or the residence exception apply when a foreign owner sells a rental?

Both breaks are written around the buyer's intended use

Section 1445(b)(5) says no withholding is required if the property is acquired by the transferee for use as a residence and the amount realized does not exceed $300,000. Section 1445(c)(4) says that where the property is so acquired and the amount realized does not exceed $1,000,000, the 15% in subsection (a) is applied by substituting 10%. Neither provision asks how the seller used the property.

The IRS exceptions page fills in the residence test. The transferee or a member of the transferee's family must have definite plans to reside at the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the transfer, days the property is vacant are not counted, and for this exception the transferee must be an individual. Publication 515 restates the tiers: no withholding at $300,000 or less, 10% above that, and 15% when the amount realized exceeds $1,000,000.

So the question at a rental sale is who is buying. A family that will move in can bring the price under the exception or the reduced rate. An investor, a corporation, a trust or an LLC cannot, because the buyer must be an individual with plans to live there.

What that means for a foreign owner selling a rental

A rental condo in Phoenix sold to a couple who will live in it is a residence sale for FIRPTA purposes, even though it was never your residence. A rental sold to a landlord is not. The thresholds are measured on the amount realized, which the Instructions for Form 8288 define as the cash paid, the fair market value of other property transferred and any liability the buyer assumes or takes subject to, so a $280,000 price with an assumed $50,000 loan is a $330,000 sale and misses the exception.

The IRS FIRPTA questions add at question 17 that the exception does not apply if the total amount realized exceeds $300,000, even when each of several sellers' shares is $300,000 or less. Co-owned rentals cannot be split into exempt pieces.

Between the two thresholds the reduced rate is what applies, and the difference is real money: at $650,000, 10% is $65,000 held back rather than $97,500.

The exception removes the deposit, not the tax

Withholding is a collection mechanism. Section 897(a)(1) still treats the gain as effectively connected income taxed at graduated rates, and the seller still files Form 1040-NR for the year. A sale that escapes withholding under the residence exception leaves the tax to be paid with the return rather than deposited at closing; a sale withheld at 10% leaves a smaller credit to claim. How the gain is taxed, and the no-election rule for real property gains, is on whether a nonresident alien can do a 1031 exchange.

The exception also does nothing for a buyer who gets it wrong. The IRS page says the buyer must have definite plans to reside, and the withholding duty belongs to the transferee under section 1445(a), so a buyer who cannot honestly make that statement will withhold the full amount. Expect the title company to ask the buyer to sign a statement of intended use, and expect some buyers to decline.

Where the 1031 exchange fits

For a foreign owner exchanging, the residence exception can remove the withholding problem entirely when the buyer qualifies, which sidesteps the Form 8288-B timing described on FIRPTA withholding in a 1031. The full proceeds reach the intermediary on closing day and the 45-day and 180-day periods run without a large sum sitting in escrow.

When the buyer qualifies only for the 10% rate, the certificate application is still worth filing, because 10% of the price is still a large sum to hold back from the exchange. The application is made on the nonrecognition ground for a full exchange or the maximum tax liability ground when boot is expected, which is on the FIRPTA certificate when an exchange has boot. The buyer then withholds at 10% and holds the money until the IRS rules.

If the exchange replacement is a DST interest, the sale side is unchanged; the trust-level withholding that follows is on DSTs for foreign investors.

Hypothetical: the same $650,000 condo, three buyers

A nonresident owns a rental condo and sells it for $650,000 with no assumed debt. All figures are hypothetical and rounded; confirm your own with the closing agent and your preparer.

Buyer A is an investor who will keep renting it: 15% of $650,000, or $97,500, is withheld. Buyer B is a couple who will live there most of the year: 10%, or $65,000. Buyer C buys a different unit from the same owner for $290,000 to live in: no withholding at all, and the owner files Form 1040-NR the following year to report the gain and pay the tax. In each case the gain is the same; only the deposit changes.

What to put in the listing and the contract

None of this applies to a seller who is a US citizen or green-card holder, who signs a certification of non-foreign status instead, as described on green-card holders and 1031 exchanges.

• Ask the buyer's agent early whether the buyer is an individual who intends to occupy the property; it changes the closing cash by five or fifteen points of the price.
• Include the assumed or subject-to debt when testing the $300,000 and $1,000,000 thresholds.
• Have the buyer's intended-use statement signed before closing so the title company can apply the right rate.
• If the buyer qualifies only for 10%, still file Form 8288-B by the transfer date for an exchange.
• Remember the tax is unchanged; the return is still due by June 15 of the following year for a nonresident with no US wages.