Back around Christmas, 2008 I co-authored a blog with Miami tax attorney Shawn Wolf, Esq. on the issue of a FIRPTA transaction coupled with a short sale.  The analysis showed that there were no specific IRS regulations and no rulings regarding a short sale transaction that was subject to FIRPTA.  See FIRPTA and SHORT SALES - DANGEROUS LIABILITY TO BUYER AND CLOSING AGENT.

Last month a communication came through from the IRS that confirmed the conclusion made in that article.  I am providing to you the question that was posed to the IRS and the answer received from the IRS for those of you that meet this type of situation:

From: CPA
Sent: Wednesday, February xx 2009
To: IRS
Subject: short sale question

Dear IRS,

I am interested in the FIRPTA consequences of a short sale.  The Regulations do not specifically discuss this type of transaction, limiting the withholding discussion to foreclosures and deed in lieu.  In short, a short sale is where a property owner sells his property to a third party buyer at (usually) a price that is "short" of the debt owed.  Thus, the bank that is involved usually receives all of the sales proceeds in repayment of the existing mortgage.  The bank may or may not forgive the debt that is not satisfied by the sale, and a decision on this issue may not be made for several months or even years after the sale.

For example, assume someone (an NRA) bought a home for $500,000 cash and thereafter borrows $800,000 when the value increased to $1,000,000 (80% LTV).  Due to the market conditions, the owner short sells the property and the sale is consummated for $750,000. 

Would the FIRPTA withholding in a situation like this be based on:

•1.       the $750,000 sales price, noting that the bank may or may not forgive the $50,000 of additional debt; or

•2.      The "amount realized" of $800,000 (the sale price PLUS the potential debt forgiveness)?

Would the IRS grant a withholding certificate in a situation like this?  If so, what needs to be explained about the short sale and the debt?

If the answer is 1., above (i.e., withholding is based on $750,000), if the $50,000 debt is later forgiven is there any FIRPTA withholding requirement at that time?  Consider that the debt would then be an unsecured promise to pay (as the U.S. real property interest was sold).

I would like to think that the "right answer" is that withholding would be based on the $750,000, that a withholding certificate could be obtained based on gain of $250,000 (i.e., $750,000 less the $500,000 purchase price), and that the forgiveness of the debt does not trigger any additional FIRPTA withholding obligations.  This would seem to be a result that is consistent with the Regulations on foreclosures and on deed in lieu, but is clearly neither of these transactions.  Of course the bank would not be happy to hear it is not getting $750,000 but $750,000 less the withholding.

The response received from the IRS was:

From: IRS
Sent: Thursday, February xx 2009
To: CPA
Subject: RE: short sale question

CPA,

When the regulations do not specifically address an issue, general law applies.  The answer to short sale questions is clearly set forth in the definition of the "Amount Realized" per Treas. Reg. 1.1445-1(g)(5).  This regulation section defines Amount Realized as follows:

1. The cash paid or to b paid,
2. The FMV of other property transferred or to be transferred, and
3. The outstanding amount of any liability assumed by the transferee or to which the US real property interest is subject immediately before and after the transfer.

As you know, the withholding is based on the Amount Realized.  Therefore, in the example you set forth, the withholding would be based on $800,000 (Sales price plus outstanding liability assumed).

Also, as you correctly alluded, Foreclosures and Deed in Lieu of Foreclosure are different from short sales.

Take care,

Senior Program Analyst

Foreign Payments

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Copyright 2009 Richard P. Zaretsky, Esq.

Be sure to contact your own attorney for your state laws, and always consult your own attorney on any legal decision you need to make.  This article is for information purposes and is not specific advice to any one reader.

Richard Zaretsky, Esq., RICHARD P. ZARETSKY P.A. ATTORNEYS AT LAW, 1655 PALM BEACH LAKES BLVD, SUITE 900, WEST PALM BEACH, FLORIDA 33401, PHONE  561 689 6660   RPZ99@Florida-Counsel.com - FLORIDA BAR BOARD CERTIFIED IN REAL ESTATE LAW - We assist Brokers and Sellers with Short Sales and Modifications and Consult with Brokers and Sellers Nationwide!  Shortsales@Florida-Counsel.com  New Website www.Florida-Counsel.com.  See our easy to find articles at Need Short Sale Information? - These Articles Probably Answer Your Question