Most investors in the valley like to use what we call a muted contract. A muted contract is just the basics; buyer, seller, who will pay the fees and the closing date. When using a muted contract, in most cases, you remove all the contingencies that are in the standard AAR (Arizona Association of Realtors) contract. Typically an investor/buyer pays all costs and only has a few days for inspection, if any at all, before the earnest money goes “hard” or non-refundable for any contract reason. One item I really feel should be added back into the muted contract for those of you that do use it as your primary form of contract is the section on FIRPTA (Foreign Investment in Real Property Tax Act). This tax is assessed to the buyer of a property who is acquiring said property from a foreign person or entity. If you do not require the seller in your contract to disclose this information to you then you may end up with a major tax consequence.
The AAR contract Reads as follows… IRS and FIRPTA Reporting: Seller agrees to comply with the IRS reporting requirements. If applicable, seller agrees to complete, sign, and deliver to Escrow Company a certificate indicating whether the seller is a foreign person or a non-resident alien pursuant to the Foreign Investment in Real Property Tax Act (“FIRPTA”). Buyer and seller acknowledge that if the seller is a foreign person, the buyer must withhold tax equal to 10% of the purchase price, unless an exemption applies.
Now, that 10% would be due to the IRS within 20 days of closing. The only way around that would be if PRIOR to closing the IRS receives all the documentation necessary to review for request of a withholding certificate. A withholding certificate would be issued only if the IRS feels there is no tax liability, example of this would be due to loss at sale. Otherwise if that money is not in the IRS’s hands on that 20th day there will be penalties and late fees added to the 10%. This is really a very costly oversight if it is not disclosed and handled properly.
I don’t know about you, but I would hate to dig in my pockets to pay the IRS 10% of the sale price because I was not aware the seller was a foreign person and bought a property from them. Canadian owners are not especially happy with our US economy right now and they are pulling out in droves. Your title company is not responsible for finding out or disclosing this information to you. Typical turn times from open to close on investment properties are about 5 to 7 days. That doesn’t leave much time during the contract negotiations to figure this out. Most 30 to 60 day escrows have a hard time dealing with this issue prior to close as it requires work with the IRS and we all know that process can be slow and painful. Please remember your P&L and protect your asset from the IRS by adding the FIRPTA langue back into your muted contracts today.
Remember, Chicago Title is here to help with anything you need and just a phone call away!