LLC With a Foreign Member: FIRPTA, Section 1446 Withholding and the 1031 Exchange

Start with the LLC's tax classification, because it decides who the transferor is

FIRPTA withholding under section 1445 falls on the buyer when the transferor of US real property is a foreign person. Reg. section 1.1445-2(b)(2)(iii) says a disregarded entity cannot certify that it is the transferor; its owner is the transferor and must give the certification of non-foreign status.

A multi-member LLC taxed as a partnership is different. The LLC is the seller, and a domestic partnership is a US person, so it can give the buyer a non-foreign certification even though one of its members lives abroad. The withholding question then moves inside the partnership.

Classification also decides the exchange. Either way the taxpayer for section 1031 is the one that holds title for tax purposes: the partnership, or the foreign owner of a disregarded LLC. Members of a partnership cannot exchange their interests, a point covered in partners who want different replacement properties.

Multi-member LLC: section 1446 governs, and only recognized gain is withheld on

A domestic partnership that disposes of US real property with foreign partners is in principle covered by section 1445(e)(1) under Reg. section 1.1445-5(c). But Reg. section 1.1446-3(c)(2)(i) says a partnership subject to both rules follows section 1446 only, and one that complies with section 1446 is deemed to satisfy section 1445. A partnership relying on a nonrecognition provision must still deliver the notice described in Reg. section 1.1445-5(b)(2) by the 20th day after the transfer.

Under section 1446(a) the partnership pays tax on effectively connected taxable income allocable to foreign partners. The IRS partnership withholding page gives the current rates, 37% for non-corporate and 21% for corporate foreign partners, and the forms: Form 8813 for payments, Form 8804 for the annual return and Form 8805 for each foreign partner.

Gain deferred under section 1031 is not recognized, so it is not part of that income. Boot is. Section 1446(d) gives the foreign partner a credit for its share of the tax paid, which it claims on its own US return.

Single-member LLC owned abroad: the buyer withholds 15% unless the IRS issues a withholding certificate

The IRS FIRPTA page sets the rate at 15% of the amount realized. For a simultaneous swap, a foreign seller can sometimes avoid withholding with a notice of nonrecognition, but Reg. section 1.1445-2(d)(2)(iv) denies that route for a deferred exchange where the buyer cannot tell at closing that the exchange has been completed. That describes almost every exchange through an intermediary.

The answer is an application for a withholding certificate on Form 8288-B, based on nonrecognition treatment. If the application is submitted on or before the closing, the amount withheld is not paid over until the 20th day after the IRS mails the certificate or a denial, and the IRS normally acts within 90 days of a complete application. Our Form 8288-B at closing page covers the escrow mechanics.

Build the timeline around it. The instructions require the seller to tell the buyer in writing, on or before the day of transfer, that a certificate has been applied for, and the 15% sits with the closing agent rather than with the intermediary while the IRS decides. The exchange clock does not wait, so if the money is not released in time to buy the replacement, the owner adds other cash or accepts that the shortfall is boot. Run your own numbers with your CPA.

A foreign member who wants out triggers section 1446(f), not an exchange

A member's LLC interest is not real property for section 1031, so a foreign member who wants cash cannot exchange it. If the member sells the interest, the IRS partnership withholding page explains that section 1446(f) requires the buyer to withhold 10% of the amount realized when the gain would be effectively connected, and that a partnership distribution producing gain under section 731 can also be a transfer.

If the foreign member wants to defer, the structure has to change before the sale, for example a drop of tenancy-in-common interests so the member holds real estate directly; see drop-and-swap strategies. The member then sells as a foreign transferor and needs its own Form 8288-B.

A redemption paid from LLC cash is no cleaner for the departing member: any gain under section 731 is a transfer the IRS page describes as reachable by section 1446(f), and the remaining members' exchange is unaffected only if the cash came from outside the exchange. The partner buyout with a cash out DST guide shows one way to fund that kind of redemption before the sale.

Worked model, and what changes when the LLC exchanges into DST interests

Hypothetical round numbers. An LLC taxed as a partnership is owned 60% by a US member and 40% by a non-US individual. It sells for $5,000,000 with a $2,000,000 adjusted basis, a $3,000,000 gain, and exchanges all but $500,000. Recognized gain is $500,000; the foreign member's 40% share is $200,000, and section 1446 tax at 37% is $74,000, credited against that member's US tax. With no exchange, the foreign share would be $1,200,000 and the withholding $444,000. Run your own numbers with your CPA.

If the LLC buys DST interests, Rev. Rul. 2004-86 treats it as owning an undivided share of the trust's real estate, so the foreign member's share of future rent and gain stays US-source. Whether that rent is effectively connected or 30% withholding income depends on facts; the IRS page notes that non-effectively connected income falls under the 30% regime, and section 871(d) lets a nonresident individual elect to treat US real property income as effectively connected. See foreign investors and DSTs and check state withholding at closing as well.