Income Tax Return Deduction Refund Concept

At DIRECTS (Domestic and International Real Estate Closing Services), we help 100’s of non-US sellers of US real estate obtain their US Individual Taxpayer ID Numbers (ITIN’s) each year. The ITIN procurement process is critical for foreign sellers of US real estate. If they do not successfully obtain an ITIN, they will never obtain a refund of the large 15% of the gross sales price withholding tax withheld from them at sale (which is entirely refundable if they did not make a large gain on their sale of US real estate).  The ITIN procurement rules have recently undergone significant change (although they have returned, more or less, to where they were before the changes mandated by Congress in January 2017).

Q1) What Were the Changes to the ITIN Program?

A1) Effective January 1, 2017, certifying acceptance agents (private tax professionals who are approved by the IRS) (“CAA’s”) were no longer permitted to certify the passports of non-US sellers of US real estate. This became a huge problem for foreign sellers of US real estate, who need ITIN’s to obtain refunds of their IRS and withholding taxes.

What is the 8288-B Process?

By Michael W. Brooks

Non- US sellers of US real estate are subject to a withholding tax at time of sale (either 15% or 10% of the gross sales price). The withholding tax isn’t really a tax, it’s better thought of as a security deposit to ensure the real tax eventually is paid by the non-US person (so the IRS doesn’t have to trust the foreign seller to mail in a check from their home in Shanghai). In 98 or 99 out of 100 instances , the withholding tax amount of 15% or 10% of the sales price will exceed (and maybe greatly exceed) the actual federal income tax owed by the foreign seller (for a rough estimate of the income tax due- simply multiply the seller’s gain made on the sale x 15%). But note the normal refund process (of the withholding tax minus the real tax) requires the foreign seller to wait until January of the next calendar year to simply file a tax return to obtain the refund, and the refund itself will take a few months to arrive after the filing. So the foreign seller must sometimes wait up to a year and a half after the sale to obtain this sizable refund. The IRS Form 8288-B withholding certificate application (via an experienced tax professional because this work is tricky) offers an alternative to this absurdly long wait.

Congress just enacted a significant change to the required withholding tax on sales of US real estate by non-US persons, effective on real estate sales closing on or after February 17, 2016. On December 18, 2015, Congress enacted the “Protecting Americans From Tax Hikes Act of 2015 (the “New Tax Law”).

Here’s all an escrow officer really needs to know about the New Tax Law…

What Was the Withholding Tax Law on Real Estate Sales By Non-US Persons (prior to the February

Starting in 2016, US individual taxpayer ID numbers (“ITINs”) not used in the prior 5 years on a US tax return will be deactivated by the IRS.  So, staring in 2016, if a foreign person hasn’t sold US real estate since (at the latest) 2010 (which should have led to them doing a tax return in 2011), the ITIN they are giving to their escrow officer is very likely no longer valid. In my experience as a tax attorney and the President of a tax firm which works daily with foreign sellers of US real estate, the use of an invalid ITIN can be one of the biggest headaches the foreign seller will ever encounter in their dealings with the IRS.  And you can bet a foreign seller not receiving a proper IRS refund will be none too shy about letting their escrow officer know all about the problem.  As the age old saying goes: happy foreign seller, happy escrow officer (or something like that).

Why is a Valid ITIN So important to the Foreign Seller?

The stakes for the foreign seller are simple- he or she will need a valid ITIN to obtain a (very possibly large) refund of the federal taxes sent into the IRS by escrow (and maybe the California state taxes too).  The federal taxes are the big one.  Recall the Internal Revenue Code generally requires the buyer (really the escrow company on the buyer’s behalf in California) to “withhold” 10% of the gross sales price from the foreign seller, and transmit the 10% withholding tax to the IRS at the time of sale (or at least keep the withholding tax in a client trust account while the IRS reviews the seller’s 8288-B withholding certificate application, if applicable).  But the 10% withholding tax is almost surely more than the seller really owes in federal income taxes on the sale.  For example, if a foreign person bought a Los Angeles vacation home a few years ago for $800,000, and then sold the house for $1,000,000, the escrow company would be required to withhold $100,000 ($1,000,000 x 10%) at the time of sale.  The escrow company then sends the $100,000 into the IRS at close (assuming the seller does not file an IRS Form 8288-B with the escrow company holding the withholding tax in a trust account).  But while the IRS holds onto $100,000 of the $1,000,000 sale’s proceeds, the foreign seller’s real income tax bill on the sale would likely be closer to $30,000 ($200,000 appreciation x 15% capital gains rate= $30,000).  So in this example the IRS is holding onto an extra $70,000 of our foreign seller’s proceeds, and our seller will undoubtedly be quite eager to receive the $70,000 back.  But our foreign seller could be in for quite a wait if the escrow company sent in the $100,000 withholding tax with an invalid ITIN.  Let’s see why….

As you know, procuring ITIN’s for non-US citizen/residents is essential when these individuals sell (or rent) US/California real estate.  Starting in 2015, the IRS has made an already challenging process even more cumbersome.  In 2016, the IRS plans to add yet another layer of complexity.
2015 Change- Form 8288’s Now Really Must be Included in ITIN Applications
If you’ve ever read through the W-7 Instructions (Application for ITIN’s), where a foreign person needs an ITIN due to 3rd party withholding on a disposition of US real estate, you’ll note there has always been a requirement that an IRS Form 8288 be included (showing the amount withheld at the close).  But prior to 2015 at DIRECTS we were able to routinely obtain ITIN’s for our clients without submitting the Form 8288’s.  This was a real advantage since the other requirements of the W-7 (the certified passport (we are permitted by the IRS to certify foreign passports at DIRECTS), the estimated closing statement, the sales contract) all could be sent into the IRS at the beginning of escrow.  This meant there was a good chance we could get our client the ITIN (assigned by the IRS) before the closing date. This allowed the foreign seller to avail him or herself of the reduced California withholding if applicable (the 12.3% x the appreciation or no withholding for a loss sale…either usually better than the default of 3.3% x the gross sales price requirement), since the seller must have an ID number in place at close to take advantage of those options).  In addition,  some escrow companies want the ITIN in place as of the close date for the purposes of the IRS Form 1099.  But under the new interpretation of the rule (requiring an 8288 with the W-7), it would really be impossible to have an ITIN by the close since the 8288 is not completed typically until right at the close.