Tax Notices – More Important Than You Think…
Authors: Stan Mullin, CCIM, SIOR
and Richard L. Riemer, attorney
Have you ever thought about what happens when a foreign individual or entity sells a property for a gain and then leaves the country with all of the sale proceeds and without paying tax on the gain? For those of us that pay capital gains taxes, it would be frustrating to know that we pay our 20% and others do not. The IRS and most states have made provisions for just this scenario, to insure that tax is collected on all gain.
This article will address a few suggestions for principals and their brokers, to insure that you comply with the law and avoid unexpected costs in your next sale or purchase.
First, by use of the term Tax Notice, we refer to any notice required by a federal or state agency as it pertains to disclosure and obligations on real property transfers, subject to capital to gain.
If You Are The Buyer –
Internal Revenue Code Section 1445 requires that all buyers of any interest in any real property located in the United States withhold and pay over to the IRS ten percent (10%) of the gross sales price within ten (10) days of the sale, unless the buyer can adequately establish that the seller was not a foreign individual or entity. The ten percent (10%) amount is generally calculated on the gross sales price…. the sum of: a) cash paid (or to be paid as in the case of an installment sale, b) the fair market value of other property transferred; and c) the outstanding amount of any liability assumed or to which the property was subject immediately before and after the sale.
Depending on the structure of the transaction, the tax withholding liability could exceed the net cash proceeds to be paid to a foreign seller at closing. Nevertheless, the buyer is still required to withhold the full ten percent (10%) and pay it to the IRS within ten (10) days of the sale, absent a “qualifying statement” or other relief. Buyers should consult their legal and tax advisors concerning the manner in which tax payments must be processed.
Buyers do not need to comply with federal withholding requirements if they obtain adequate proof that the seller(s) are not foreign individuals or entities. A properly written Non-Foreign Tax Certification, executed by the seller(s) of commercial property, under penalty of perjury generally will constitute adequate proof of buyers that the seller(s) are not foreign individuals or entities (we assume that the buyer(s) do not have knowledge that the certification is false).
How long do you have to keep a copy of the certification?
Six (6) years is recommended, but you should consult with your tax and legal advisors to determine a) what constitutes adequate proof and b) and the length of time the proof is to be retained, for each transaction.
Are there exemptions from this 10% federal withholding requirement?
Yes, in cases where a home is purchased: a) for less than $300,000 as the buyer’s
primary residence and b) the buyer occupies the home for more than 50% of the
time for each of the first two-(s) years after the purchase.
If you are the Seller
–
To avoid or mitigate escrow’s or the buyer’s deduction of
10% of the purchase price you should obtain a “Qualifying Statement” from the
IRS before the transaction is consummated. Once you have the Statement
insure that you provide it to the buyer. If the sale closes before you have
obtained the Qualifying Statement, is it too late to receive your remaining 10%?
Not always, because in some circumstances the seller can apply for an “Early
Refund”.
Are There State Tax Obligations?
In California, yes. Our state imposes an
additional withholding requirement equal to three and one-third percent (33
and 1/3%) of the gross sales price, not only on foreign sellers, but also out-of-state
sellers and sellers leaving the state, if the sales price exceeds $100,000.
Generally, withholding is required if the sales proceeds are dispersed outside of
California, if the last known address of the seller is outside California or if a
financial intermediary is used.
Who withholds the proceeds, escrow or the buyer?
It varies throughout the U.S., but in California, the southern half of the state typically deals with the
issue differently than the north. Southern California escrow offices typically
provide the Non-Foreign Tax Certification and Qualifying Statement forms to
the seller as a part of the standard escrow documentation that must be executed
by the seller and returned, before an escrow account is opened and a number is
assigned. As such, the escrow company will review the documents and decide if any of the buyer’s funds will be set aside from the seller’s proceeds to meet any tax obligation. Northern California escrow offices typically do not provide these documents. Many have determined that they do not want to be in a position of receiving these documents, determining their validity and then deciding on the disbursement or withholding of funds. In this circumstance it is the buyer that must make the determination to withhold funds to meet federal and/or state tax obligations. The following case study should help clarify the issue…
Case Study – What do you think are the tax obligations at the time of sale in the following scenario? A U.S. corporation, with 80% of the shares owned by a foreign individual, sells a property for a gain, no funds were withheld and paid over to the IRS and a Tax Notice was not filed. First, it is likely that none of the proceeds should have been withheld because even though the majority shareholder was foreign, the selling entity was a U.S. corporation (i.e. a California corporation). Second, the broker or tax advisor should probably instruct the seller to sign and keep on file the Tax Notice confirming that the seller was not foreign. But what if the circumstances were the same, except that the seller was a foreign individual?
Not surprisingly, the IRS and state taxing authorities have the right to pursue the tax obligation on parties other than the seller. The taxing authorities will typically pursue the seller first for the tax due on the gain. If they are unable to collect from the seller, the buyer is often the next party that the taxing authorities will look to for the obligation. It would not be uncommon for a lien to be placed on real property owned by the buyer in their effort to collect the funds, which were due as a part of the transfer. The real estate broker(s) and in some cases escrow and or title company may be subject to the governmental agencies effort to collect the outstanding tax balance.
Keep in mind that there are penalties for non-compliance with IRS Section 1445 and for making a false statement on the forms. Parties that make false statements on these forms can be subject to fines and / or imprisonment.
In closing, buyers, brokers, escrow offices and sellers should all pay particular attention to these issues as the cost for
non-compliance can be high. In all cases, review the specifics of your transaction with your legal, tax and real estate advisors before you commit to any transfer.
Stan Mullin, SIOR, is a Senior Vice President in the Newport Beach office of Grubb & Ellis and specializes in corporate real estate matters. You can learn more about his firm by looking up www.grubb-ellis.com and he can be reached at
smullin@earthlink.net.
Richard L. Riemer is a real estate attorney in private practice in Santa Ana and is the attorney for the Forms Committee of the American Industrial Real Estate Association (“AIR”). Mr. Riemer drafted the Sellers Mandatory Disclosure Statement referred to in this article. You can contact the AIR at (213) 687-8777 or reach them through their web site at
www.airea.com.
