SHORT SALE AND FIRPTA TAX WITHHOLDING - IRS ISSUES PRIVATE GUIDANCE

By
Real Estate Attorney with THE ZARETSKY LAW GROUP - Board Certified Real Estate Atty and AUTOMATED LAND TITLE COMPANY
https://activerain.com/droplet/4m5X

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

----------------------------------------------------------

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

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Rainmaker
1,317,601
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

Thanks for the update and the letter from the IRS.  Very interesting.

Mar 05, 2009 01:47 PM #1
Rainmaker
4,797,764
Gabe Sanders
Real Estate of Florida specializing in Martin County Residential Homes, Condos and Land Sales - Stuart, FL
Stuart Florida Real Estate

Richard, thanks for the post.  Doesn't look like the IRS is about to give any breaks to any one here.

Mar 05, 2009 11:40 PM #2
Rainmaker
150,060
Janie Coffey
First Coast Sotheby’s International Realty - Ponte Vedra, FL
Uniting Extraordinary Homes w/ Extraordinary Lives

Richard, thank you so much for keeping us informed!!! I really do love your blogs and soak each one up like a sponge!

Mar 06, 2009 10:51 PM #3
Anonymous
A. Alvarado

In your example there is a gain on the sale.  Does anyone have an opinion if the seller realizes no gain?  For example if they purchased for $560,000, with a mortgage of 500,000 and the short sale price is $315,000.  It would seem this example would qualify for an IRS exeception since there is no gain. 

Apr 21, 2009 07:04 AM #4
Anonymous
Shawn Wolf

As a general matter, and except in limited circumstances not applicable to a sale, FIRPTA withholding does not use "gain" as the measuring stick.  Instead, withholding is based on the "amount realized".  Consistent with the suggestions made in the article, where there is "no gain" a withholding certificate could be applied for and, if issued, ultimately reduce the withholding to $0 (maximum tax where there is "no gain").  This may delay the taxpayer receiving the funds (due to the withholding escrow), but the money will not be in the IRS coffers. 

Of course, certain ancillary issues (such as the potential taxation of "cancellation of indebtedness income") would need to be resolved in order to confirm that there is no "gain" within the broad meaning of the U.S. tax laws.  As a bottom line, the uncertainty with resepct to several of these issues and the related complexity of the tax law is is why compentent tax professionals should be consulted in advance of a real estate sale involving a foreign person (whether buying or selling, and regardless of it being a short sale or not).   

With all of the above being said, please understand that this response is a general comment about the U.S. tax lawand is not expressing a legal opinion about the very general fact pattern raised herein.  As such, this breif response may not be relied upon for any purpose.  Please consider obtaining formal legal advice if you have a specific fact pattern with respect to which you need an answer.

Apr 22, 2009 02:15 AM #5
Anonymous
Tax_Guru

Nice to hear that the IRS are also helpful...for more <a href="http://www.protaxcare.com">tax help</a> visit us at www.protaxcare.com

Sep 14, 2009 05:12 PM #6
Anonymous
Craig

Your IRS agent didn't answer your question thoroughly. He said the witholding amount would be equal to the sales price "plus outstanding liability assumed".  Then he goes on to talk about the sales price of 800k which was not the sales price at all  That was the amount of money borrowed??? The Sales price in a short sale is the contract price of 750,000.00. ( The cash paid or to b paid) As you stated in your question you don't know for sure if the lender is going to forgive the debt, accordingly until the debt is forgiven it was not "assumed" by anyone and I think its a stretch to say that the lender "assumed" the debt they forgave you but certainly it isnt assumed by anyone until forgiven. I think your IRS source was very sloppy in his answer and I have more questions now then when I began researching this topic.

 

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 - That is talking about a Deed subject to a mortgage situations where the NRA seller deeds the parcel in exchange for somone taking over the payments and maybe gets some other property as well.

 

in the Tres Reg cited above the first item stands alone as to amount relaized Then in the second situation the 2 and 3 if you wil have to read together becasue it contemplates a non money based exhange so if a citizen was to buy from a NRA seller and bought with other property and assumed the NRA's debt the amount realized would be both the debt assumed and the FMV of the "property"

 

The IRS agent has to be wrong in his analysis to you or maybe I am missing something.

Jul 19, 2010 03:38 PM #7
Anonymous
Shawn Wolf

Craig,

The IRS agent actually focused on the term "amount realized", which is not necessarily the sales price.  In fact the IRS agent clearly states that the amount realized is the slaes price PLUS the amount of debt releived (which is a correct statement).  What I do agree with you on is that an issue exists as to whether or not the debt is being relieved and should be made part of the amount realized where it is not clear that the debt will, in fact, be forgiven.  I would guess that this is a case of the IRS giving informal advice in a situation where there is no guidance and taking the most IRS favorable reading (which is arguably consistent with the intent of the FIRPTA withholding ... i.e., withhold and let the NRA file a tax return to get the money back if it isnt due so as to protect the U.S. tax base).

Regardless, and the bottom line of the Blog / follow-up is that a short sale is neither a forclosure nor a deed in lieu and thus the results may be surprising.  Depending upon who you represent (e.g., the buyer, the seller or the bank) you may want to interpret the rules differently.  Thus, the conservative thing to do (especially for the buyer's protection) is to obtain a withholding certificate or else withhold to the "maximum extent" (consistent with the IRS agent's comments).  When obtaining the withholding certificate the situation can be explained as to the amount realized and the IRS can determine the liability.  Of course, if there is withholding due this might be a "deal breaker" as the bank will get even less money (so, of course, withholding is not want the bank wants, so a withholding certificate might help avoid that).  If tax will be due, and the bank is not happy, one suggestion, where possible, might be to have the bank foreclose or to do a deed in lieu and let the bank sell the property to the buyer.  This would allow for the more clearly defined FIRPTA rules to apply and avoid this problem, but I understand that there are non-tax reasons that many banks are unwilling to structure deals in this manner.

If you find anything else on pont please add it to this Blog, as we have not updated this in some time; however, at the time this was written there was not formal guidance and the Regulations did not (and I beleive still do not) consider a short sale any differently than a "normal sale".

Jul 20, 2010 01:41 AM #8
Anonymous
Craig

Thanks for the response Shawn - I am going to definetly suggest that a withholding certificate be obtained in my transactions.

I figured out what was throwing me it just so happens that the refiancne amount of 800k so the amount of the contract sales price and the amount "assumed" will always add up to the amount borrowed in a short sale situation provided that the debt is forgiven.If the IRS agent had gone through the mechanical math of 750+50 I would have understood right away. last night I saw the 800k twice and just assumed the IRS agent made a mistake in my haste.Thanks for the clarification

 

In a situation of unknowns OR where the lender refuses to waive the deficiency I think I can safely articulate to the IRS that the amount realized was simply the short sale contract price. I am getting ready to do quite a few of these I will share my horror or success stories as they occur

Jul 20, 2010 01:07 PM #9
Anonymous
Frank

O.K.,a hypothetical situation..An NRA buys a house for $2.0 million,and takes a mortgage for $1.6 million.A few years later ,after a devastating decline in Market value,he throws in the towel,and agrees to a sale of $1.2 million,thereby locking in a loss of $0.8 million.The bank records a COD(cancelation of indebtedness ) of $0.6 million including the mortgage write down and other related trasactional costs:1) the seller has a $0.8 million loss ;2) the value of the COD to the seller  is $0.6 million; 3) and the seller has a net loss of $0.2 million.Questions:What does the buyer have to withhold in the escrow account?If a witholding certificate is applied for (stating the above facts),will the withheld amount be returned to seller?If the buyer establishes the escrow with his own funds and the seller agrees to assign the escrow amount to the buyer(or to the sellers U>S> agent and then to the buyer),will the buyer be successful in recovering his  escrowed funds? What are the risks to the buyer under these circumstances?Any and all answers would be appreciated,since I am seeing a potential for transactions similar to this occuring,albeit for larger and smaller amounts.

Aug 09, 2010 03:50 PM #10
Anonymous
Shawn Wolf

Frank,

As noted elsewhere there is not a lot of published guidance, so most of what you will find is discussion or practical advice.  I may have a similar case to what you are explaining that I wil be obtaining a withholding certificate but I have yet to be engaged so at this point it is yet to be something I have had to go through.

As to your questions:

1. My understanding is that the IRS will require withholding on the amount realized, which includes the cash payment plus the debt forgiven.  In this case that should be $1.6 million (I think your computation of the CODI might be incorrect, as I see the CODI being $400K [1.6 - $1.2]).  Assuming my math is correct, the withholding would need to be $160,000 (10% of 1.6 million).

2.  As to the escrow, the normal situation is that the seller gets the money.  If the contract says that the buyer gets it back, or possibly that it is paid to the bank, then the money should go where the escrow agreement provides.  This is a matter of contract law and isn't a tax issue; however, the risk is that the withholding certificate is not granted for some reason and the money goes to the IRS, at which point nobody will get the money back (except the seller, as part of a refund application).

3.  What are the risks?  Well, the main risk has already been expressed in a non-technical answer: that the withholding certificate will be denied.  How is this possible when there is clearly a loss?  Well, the answer is simple: although there is clearly a FIRPTA loss of $800K in your example, the question that remains unanswered is how the CODI of $400 will be taxed.  Assuming that one of many exceptions to CODI do not apply to this situation (something that must be reviewed), then the issues become how the CODI will be taxed.  Presumably, and looking at the prior IRS correspondence, the IRS is treating the CODI as FIRPTA related gain (and therefore ECI) and thus is allowing the "CODECI" of $400K to be offset by the overall FIRPTA loss of $800, resulting in a net effectively connected loss of $400K.  The "risk" is this is not correct, that the CODI is U.S. source FDAPI and subject to 30% withholding.  If this is the case, 30% of $400K is $120,000 and this becomes the maximum tax liability.  With this being said, it may be that the withholding certificate computation would need to be stated VERY CLEARLY in order to try to be able to have this issue clarified as part of the overall response.  Otherwise, the buyer may receive "FIRPTA clearance" but in theory could still be "on the hook" for the 30% withholding on the CODI. 

The other risk is the bank may need the withholding certificate prior to closing.  As you know , the timing of obtaining these things is not easy.

Again, as I have not had a client engage me to formally run one of these through the entire process, I have not had the opportunity to consider all of the issues listed above to draw particular conclusions.  Obviously, in even worse facts, withholding can clearly be due. 

I hope this helps to some extent.  Let me know if I can be of additional service to you or your clients.

Shawn

 

Aug 10, 2010 03:10 AM #11
Rainmaker
281,515
Richard Zaretsky
THE ZARETSKY LAW GROUP - Board Certified Real Estate Atty and AUTOMATED LAND TITLE COMPANY - West Palm Beach, FL
Florida Real Estate Attorney

Some private emails have asked about situations where the husband is a US Citizen and the wife is not.  Foreign persons, as defined by the Act, include the following: 

Non-resident aliens (even with a social security number)

Foreign corporations that have not elected to be treated as domestic corporations

Foreign partnerships, trusts or estates

Disregarded entities (i.e. sole member LLC) unless the LLC elected to be treated as a partnership or corporation 

A resident alien, with a green card is NOT a foreign person and FIRPTA does not apply.    

First, allocate the sales price among the transferors based on capital contribution, then, aggregate the amount allocated to any foreign person.

NOTE:  The IRS treats a husband and wife as having contributed 50% each. 

The requirement for obtaining a Transfer Certificate also applies to title held by husband and wife if the decedent spouse was foreign. Although title may automatically pass to the surviving spouse under state law, the federal tax lien under the IRS Code is not relieved until a Transfer Certificate is obtained. The same holds true for the survivor of jointly held property with rights of survivorship where the decedent joint tenant was foreign

Jun 04, 2013 08:59 PM #12
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Richard Zaretsky

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