It has been more than a year since changes to the Foreign Investment in Property Tax Act (FIRPTA) withholding rules were implemented in February 2016. One of the key changes was the increase of the withholding rate from 10% to 15% of the gross sales price of a US property sold by non-US owners, with some exceptions.
Since this rate hike was implemented, more and more Canadian sellers of US properties have been considering submitting an Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests (the “8288-B Application”). The 8288-B Application allows sellers to more quickly receive a return of the portion of their proceeds that exceeds their actual capital gain liability.
A timely 8288-B Application allows the withholding agent (typically the closing agent who collects the funds at closing to be held in escrow) to legally hold the 15% withholding in their escrow account in lieu of remitting the funds to the IRS. Once the IRS approves the 8288-B Application, it will issue an approved Withholding Certificate. With the certificate in hand, the withholding agent is then authorized to release the funds back to the seller directly. As a result, the seller can get the withholding back within a few months, compared to having to apply for a refund through filing a US tax return in the following year.
Submitting the 8288-B Application is an intricate process. Remember: timing is everything. First, an application cannot be made until there is a valid Purchase and Sale Contract. Second, the application must be submitted on or before the scheduled closing date. If the application has not been sent to the IRS by the time the transaction closes, then it is considered to be untimely, and the withholding agent must remit the 15% withholding to the IRS within 20 days of closing.
This process also requires cooperation amongst the parties. It is important for a foreign seller to let both the buyer and the closing agent know early on that he intends to make an 8288-B Application in order to avoid any surprises in the days leading up to closing.
As an example, some withholding agents will only hold funds up to a certain number of days and reserve the right to remit a withholding to the IRS without notice to the seller – this is a worst-case scenario that can lead to a misplacement of funds and/or an extreme delay that significantly prolongs the seller’s ability to get funds back compared to if he had not submitted an 8288-B Application in the first place. A further added complication is if the foreign seller also needs to submit an application for US tax identification numbers at the same time as submitting the 8288-B Application.
Due to these potential complications, it is important for the seller to both communicate with the withholding agent early in a transaction to find out what the options are and to consult a cross-border legal professional as soon as property has been listed for sale.