The CPA Journal

IRS Revenue Procedure 2000-35: Dispositions of U.S. Real Estate by Foreign Persons

By John D. Hamilton, CPA, KPMG LLP

Last year, the IRS issued Revenue Procedure 2000-35, which revised the procedures for obtaining a withholding certificate to reduce the amount of U.S. tax generally required to be withheld under IRC section 1445 when a foreign person disposes of an interest in U.S. real property. The revenue procedure affects both the foreign person disposing of an interest in U.S. real property and the person to whom the property is transferred.

The revenue procedure’s guidance modifies and clarifies the provisions of Revenue Procedure 88-23 as they concern applications for withholding certificates. The new procedure took effect September 27, 2000, 30 days after it appeared in Internal Revenue Bulletin 2000-35, and supersedes Revenue Procedure 88-23, 1988-1 CB 32, which specified the procedures to obtain a withholding certificate under Treasury Regulations sections 1.1445-3 and 1.1445-6 and provided additional guidance concerning applications for withholding certificates.

Background

Under IRC section 897, foreign persons are subject to U.S. tax on gains from dispositions of interests in U.S. real property, just as if those gains were derived from a U.S. trade or business. Interests in U.S. real property include real estate located in the U.S. as well as stock of a “U.S. real property holding corporation” (generally, an entity where the fair market value of its U.S. real property interests is equal to at least 50% of the total fair market value of all its U.S. and foreign real property and business assets).

In addition to the tax liability imposed by IRC section 897, IRC section 1445 imposes a withholding mechanism that collects the tax imposed on dispositions by foreign persons of investments in U.S. real property. Section 1445(a) provides generally that a transferee of a U.S. real property interest from a foreign person must deduct and withhold a tax equal to 10% of the amount realized, which includes the amount of mortgage liabilities assumed or taken by the purchaser with respect to the real property, even if no cash consideration passes hands. This withholding requirement applies regardless of the amount of gain or loss recognized by the foreign transferor.

IRC section 1445(b) and the regulations thereunder provide several exceptions to this requirement, including an exemption from withholding for persons who purchase property for $300,000 or less for use (by the transferee) as a residence. Other exemptions include the following:

The transferor furnishes an affidavit of nonforeign status

The property transferred is stock regularly traded on an established securities market

The transferor is not required to recognize any gain or loss with respect to the transfer and certain notification requirements are met

A statement obtained from the IRS excuses withholding.

Similarly, IRC section 1445(c) provides that the amount required to be withheld can be reduced pursuant to a determination by the IRS of the transferor’s maximum tax liability upon the disposition. Treasury Regulations sections 1.1445-3 and 1.1445-6 provide rules concerning IRS issuance of a withholding certificate that reduces or eliminates withholding.

Withholding Certificates

The procedures for obtaining a withholding certificate under Treasury Regulations sections 1.1445-3 and 1.1445-6 are largely unchanged. However, Revenue Procedure 2000-35 modifies the process and clarifies the current procedures contained in Revenue Procedure 88-23. The changes made by Revenue Procedure 2000-35 include a warning that an application will be rejected if it is substantially incomplete. The revenue procedure also emphasizes that using Form 8288B to apply for a withholding certificate under categories 1 through 3 will expedite the application process.

The most notable modifications require that all applications for withholding certificates now disclose whether U.S. income tax returns relating to the U.S. real property interest were filed in the three preceding tax years, along with their filing dates and location. If such returns were not filed, an explanation must be provided. All applications must also disclose whether U.S. income taxes relating to the U.S. real property interest were paid and, if so, the amount of the tax paid. (See “No Deductions for Nonresident Alien for U.S. Rental Income” by Anthony Sileo, The CPA Journal, July 1997.) All applications for withholding certificates must include a statement of the contract price assigned to the U.S. real property interest for which the withholding certificate is sought.

A foreign government submitting an application because it uses the U.S. real property for a diplomatic mission must submit information—

identifying the diplomatic property,

establishing the property’s use for a diplomatic mission, and

establishing that the property has been recognized by the State Department as diplomatic property subject to the Foreign Missions Act [IRC section 202, 22 USC section 4305 (1982)].

The revenue procedure clarifies that a withholding certificate will not be issued if a domestic partnership’s transfer of a U.S. real property interest is subject to both Treasury Regulations section 1445(e)(1) and section 1446 (i.e., the section 1446 withholding rules take priority over the section 1445 rules). Section 1446 imposes a withholding obligation on the effectively connected income of a partnership with foreign partners. Instead of applying for a reduced rate of FIRPTA (Foreign Investment in Real Property Tax Act) withholding under section 1445, the partnership may credit amounts withheld under section 1445 against its section 1446 withholding obligation (See Revenue Procedure 89-31, 1989-1 CB 899).

The revenue procedure also makes clerical modifications that reflect changes to the IRS’s organization, including a change of the address where applications for withholding certificates must be submitted. The instructions of Form 8288-B reflect the new address.

Editors:
Lawrence A. Pollack, JD, LLM, CPA
KPMG LLP

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