Does FIRPTA withholding apply if a foreign seller does a 1031 exchange?

Withholding turns on who the seller is, not on what the seller does with the money

Section 1445(a) requires the transferee to "deduct and withhold a tax equal to 15 percent of the amount realized" on any disposition of a US real property interest by a foreign person. A foreign person is anyone who is not a United States person, and section 7701(a)(30) defines that to include a citizen or resident, a domestic partnership and a domestic corporation.

So a US citizen living abroad or a green-card holder is not a FIRPTA seller and can give the buyer a certification of non-foreign status under Reg. section 1.1445-2(b). A nonresident alien or a foreign corporation is, whatever it plans to do with the proceeds. When a domestic partnership or LLC taxed as a partnership sells, the IRS FIRPTA page says the entity itself is the withholding agent for its foreign partners.

Amount realized is the price, not the gain. A $1,000,000 sale with a $400,000 basis still starts at $150,000 of withholding.

The notice of nonrecognition does not work for a delayed exchange

For most nonrecognition transactions the seller can sign a notice and the buyer can skip withholding. Reg. section 1.1445-2(d)(2)(iv) carves out like-kind exchanges twice: the notice does not apply "to simultaneous like-kind exchanges under section 1031 that do not qualify for nonrecognition treatment in their entirety" or to "non-simultaneous like-kind exchanges under section 1031 where the transferee cannot determine that the exchange has been completed" when its return is due.

A delayed exchange through a qualified intermediary is never complete 20 days after closing, so the notice route is closed. The regulation then says the buyer "is excused from withholding only upon the timely application for and receipt of a withholding certificate."

Form 8288-B filed by closing day keeps the 15% out of the IRS's hands while it decides

Either the buyer or the seller can apply. Under Reg. section 1.1445-3(b)(6), in a deferred exchange the buyer is excused from paying over within 20 days "only if an application for a withholding certificate is submitted prior to or on the date of transfer." A seller who applies must tell the buyer in writing on or before the transfer that the application is in.

The buyer still withholds the 15%. Under Reg. section 1.1445-1(c)(2) it need not report or pay it until the 20th day after the IRS mails the certificate or a denial, and the IRS withholding certificates page says the IRS generally acts within 90 days of a complete application that includes every party's taxpayer identification number. How that timing plays against your 180 days is covered on how long the certificate takes.

Hypothetical: a $1,000,000 sale by a nonresident owner

A nonresident sells a US rental for $1,000,000 and files Form 8288-B two weeks before closing. At closing the buyer's escrow holds $150,000 and the intermediary receives the remaining net proceeds. The figures are hypothetical and rounded; run your own numbers with your CPA and intermediary.

If the certificate issues on day 70 and the escrow releases the $150,000 to the intermediary, the whole price can be reinvested. If the escrow releases the money to the seller after the exchange has closed, that cash is taxable to the extent of gain, as with any leftover cash after an exchange. If the application is denied, the buyer remits within 20 days and the seller claims the credit on a US return.

The practical step is drafting: the escrow instruction should name the intermediary as the recipient of a release that comes inside the exchange period.

After closing, the seller still files a US return and a nonrecognition statement

The IRS stamps Copy B of Form 8288-A and sends it to the seller, who attaches it to a Form 1040-NR or 1120-F to receive credit for anything withheld, according to the Instructions for Form 8288. The return also carries Form 8824 for the exchange.

Reg. section 1.897-6T(a) lets a foreign person use section 1031 only when the replacement is a US real property interest that would be taxed on a later sale and the filing requirements of section 1.897-5T are met. Those require a statement with the return describing both properties and a signed declaration that any later disposition will be treated as taxable.

A DST can be the replacement, but ask the sponsor first

The like-kind rules are the same for a foreign seller, so a beneficial interest in a Delaware statutory trust can take the proceeds, but not every sponsor accepts non-US investors and withholding follows the investor into the trust. Those issues are on foreign investors and DSTs, and the closing mechanics are on Form 8288-B at closing.