One of the Ps buzzed me about a dividend item on a year-end brokers’ statement.
P: “What is
a Section 897 gain?”
CTG: It has to do
with the sale of real estate. It is extremely unlikely to affect any of our
clients.
P: Why
haven’t I ever seen this before?
CTG: Because this
is new tax reporting.
We are talking about something called the Foreign
Investment in Real Property Tax Act, abbreviated FIRPTA and pronounced
FERP-TUH. This thing has been around for decades, and it has nothing to do with
most of us. The reporting, however, is new. To power it, you need a nonresident
alien – that is, someone who is not a U.S. citizen or resident alien (think
green card) – and who owns U.S. real estate. FIRPTA rears its head when that
person sells said real estate.
This is specialized stuff.
We had several nonresident alien clients until we decided
to exit that area of practice. The rules have reached the point of absurdity –
even for a tax practitioner – and the penalties can be brutal. There is an encroaching,
if unspoken, presumption in tax law that international assets or activities
mean that one is gaming the system. Miss something – a form, a schedule, an
extension, an election - and face a $10,000 penalty. The IRS sends this penalty
notice automatically; they do not even pretend to have an employee review anything
before mailing. The practitioner is the first live person in the chain, He/she now
must persuade the IRS of reasonable cause for whatever happened, and that a
penalty is not appropriate. The IRS looks at the file - for the first time,
mind you - says “No” and demands $10,000.
And that is how a practitioner gets barreled into a
time-destroying gyre of appealing the penalty, getting rejected, requesting
reconsideration, getting rejected again and likely winding up in Tax Court. Combine
that with the bureaucratic rigor mortis of IRSCOVID202020212022, and one can
understand withdrawing from that line of work.
Back to Section 897.
The IRS wants its vig at the closing table. The
general withholding is 15% of selling price, although there is a way to reduce
it to 10% (or even to zero, in special circumstances). You do not want to blow
this off, unless you want to assume substitute liability for sending money to
the IRS.
The 15% is a deposit. The IRS is hopeful that whoever
sold the real estate will file a nonresident U.S. income tax return, report the
sale and settle up on taxes. If not, well the IRS keeps the deposit.
You may wonder how this wound up on a year-end brokers’
tax statement. If someone sells real estate, the matter is confined to the
seller, buyer and title company, right? Not quite. The real estate might be in
a mutual fund, or more likely a REIT. While you are a U.S. citizen, the mutual
fund or REIT does not know whether its shareholders are U.S. citizens or
resident aliens. It therefore reports tax information using the widest possible
net, just in case.
