The Large Business and International (LB&I) Division of the Internal Revenue Service on September 14 announced a new international compliance initiative targeting foreigners selling interests in U.S. real property and subject to the “Foreign Investment in Real Property Tax Act (FIRPTA). Further, over the past summer the LB&I announced that it is substantially increasing the number of audits within its global high-wealth industry group, which might well include audits in this FIRPTA compliance area.

FIRPTA taxes foreign persons on the disposition of their U.S. real property interests. Generally, the buyer/transferee is the withholding agent and is required to withhold 15% of the amount realized on the sale, file required forms, and remit the withholding tax to the IRS. The 15% FIRPTA tax is not a final tax, but, rather, a withholding tax that the foreign taxpayer credits against their calculated federal tax liability on their FIRPTA real estate gain. Through this new FIRPTA enforcement campaign, the IRS intends to increase FIRPTA voluntary compliance through issue-based examinations and external education and outreach.

Although foreigners generally are not subject to U.S. income tax on capital gains that are unrelated to the conduct of a business in the United States, the sale of a defined interest in U.S. real property (a so-called “USRPI”) is treated as income effectively connected with a U.S. trade or business, and therefore is taxable capital gain to the foreign seller. A USRPI can include a direct ownership interest in U.S. real estate, or stock of certain domestic corporations that, themselves, own substantial USRPIs. An interest in a partnership is also, in effect, treated as a USRPI to the extent that gain from the sale of a partnership interest is attributable to USRPIs owned by the partnership...