1 FAQ s (FOREIGN INVESTORS) WHAT IS FIRPTA? Foreign Investment in Real Property Tax Act, a statute that requires that a seller who is a foreign person permit a withholding of a part of the selling price against the United States gains taxes that the foreign person will owe on capital gains earned by the sale of real United States real property. WHAT CONSTITUTES A FOREIGN PERSON UNDER FIRPTA? A foreign person for federal income tax purposes is generally any person who is not either a resident alien (i.e. a holder of a green card) or a United States citizen. If an owner of real property is an entity formed outside of the United States, it is also deemed foreign person under the IRS Code (example: British Virgin Islands or Channel Islands Corporations). WHO HAS THE RESPONSIBILITY TO WITHHOLD? The IRS gives the buyer the obligation to withhold ten (10%) percent of the purchase price at closing and deliver it to the IRS when the seller of real property is a foreign person ; a failure to withhold becomes the responsibility of the buyer to whom the IRS will look for payment in the event withholding is not made. The seller must obtain a Tax ID Number in order to meet the buyer s obligations to the IRS. WHAT IF CAPITAL GAINS TAX IS MORE THAN FIRPTA WITHHOLDING? WHAT IF CAPITAL GAINS TAX IS LESS THAN FIRPTA WITHHOLDING? Remember that FIRPTA is a withholding statute and is not the seller s payment of the required gains taxes for which the seller is absolutely liable. By providing the 10%, the buyer has fulfilled all of buyer s withholding requirements and has no further obligations in this regard regardless of the correct amount of capital gains tax to be paid. The seller is required to pay the actual gains tax which may be credited toward the with-holdingholding made at closing. This is true whether the tax due is larger or smaller than the withheld amount. One must file a 1040NR (non-resident income tax return), 1120F (foreign corporation) or other entity income tax return together with the Evidence of Receipt, on or before April 15 of the year subsequent to the closing. If the withholding exceeds the tax due, the seller will be entitled to a rebate of the difference between the tax due and the withholding. If the withholding is less than the tax due, the balance is to be paid with the filing of the 1040NR or the 1120F.
2 HOW SHOULD OVERSEAS INVESTORS TAKE TITLE? Long term capital gains rates (reduced from ordinary income tax rates) are available for individuals or entities that are taxed as individuals (e.g. an individually owned LLC) after ownership of one (1) year. Corporations are taxed at the ordinary income rate regardless of the length of ownership. Currently, the long term capital gain rate is 15% (of the net gain, as defined below)and ordinary income rate varies but is approximately 35% of the net gain. Thus, in determining how best to take title, one must first determine the tax effect of the title taken. Also, if a corporation is the owner of the property, a foreign (including sister state) entity must pay NY State corporation franchise taxes and NY City general business taxes regardless of the place of incorporation (these taxes are business taxes and are NOT income taxes, which are treated separately). DOES A FOREIGN PERSON HAVE AN INCOME TAX OBLIGATION TO NEW YORK STATE? Yes. New York State Law requires that any non-resident of the State of New York must file and have a percent of the gain withheld at closing and paid to NY State before a deed can be filed IT-2663 or IT-2664 for cooperative apartments. The percent withheld varies; for 2008 the amount is 6.85% of the net gain. CAN OVERSEAS INVESTORS TAKE ADVANTAGE OF LIKE KIND TRANSFERS? Yes. But the rules are slightly different. According to 1031Vest, a qualified intermediary: Basically, because the exchanger is a foreign person or entity, a Notice of Non-Recognition Transfer needs to be delivered at the first closing, but only if the exchanger has already identified the replacement property. If the property has not been identified, the exchanger can apply to the IRS for a Withholding Certificate, which the IRS must act in within 90 days. While waiting for the IRS, the 10% withholding is held in escrow by the transferee, rather than being sent directly to the IRS within the usual timeline of 20 days after the closing. IF A BUYER OR SELLER IS AN OVERSEAS INVESTOR AND IS OUT OF THE COUNTRY, CAN THE DEAL GO TO CLOSING? IF SO, WHAT IS NEEDED? Yes. No one, whether an individual or entity, whether domestic, or overseas investor is required to be personally at a closing of property which that person(s) or entity is purchasing or selling. Indeed, it is common that the client does not go to closing and from time to time, the client may actually never be in New York during the process. This is true even where financing is being undertaken. In my practice, we commonly use a power of attorney that is specifically linked to the real estate or cooperative apartment which the client is purchasing or selling. Where financing is taking place, the lender often requires a specific reference to the loan in the power of attorney. The balance of a purchase price is usually wired into your attorney s escrow account so that it available no later than the close of business day before the actual closing.
3 What are the main steps of a sale-purchase transaction in New York? Step 1: Preparation Before you begin your journey into New York real estate, it will be helpful to get prepared so that when you find what you ar looking for, you can move quickly and secure the property of your dreams. If you are getting financing, you should speak to a mortgage broker or a banker and get prenot only help you learn how much you can approved for a loan before you start your search. This will spend but also make you a more attractive buyer and help you negotiate a better price. It is a requirement in New York to have a lawyer who can review your contract and protect your interests during the transaction. If you do not have one, we will be glad to recommend several to choose from including those whom speak your language. It is needless to say how important it is to select a lawyer who you trust and who you are comfortable with. It is very useful to speak to a good tax advisor in order to help you decide on the optimal purchase structure for your deal. Tax liability varies for US residents and non-residents, as well as whether you buy a home or an investment property. As a result, it is smart to consult with a good tax specialist, fiscal attorney or an accountant. Finally, you need to prepare you finances and especially a 10% deposit for your purchase so that it is readily available when you need it. You may consider opening a US bank account if you don t have one or otherwise transfer money to your attorney s escrow account. Step 2: Property search and an Offer Every purchase starts with the selection process. After viewing the properties and selecting the one you really like, you should make an offer to buy it. Such an offer is not binding and you can more than one offer to find the best deal. New luxury property developers (sponsors) however are less likely to negotiate the price and usually expect to sell their properties at asking price. I will always be on your side and do my best to get you the lowest price and the best deal! Once the offer is accepted by the seller, the seller s agent or lawyer sends the contract and bylaws of the building (or an offering plan for a new development) to a buyer s lawyer for review.
4 Step 3: Contract negotiation and signing The usual time for your lawyer to review the contract is 5 to 10 business days (the seller s agent of the property you choose will advise you on such time limits). Please note until such contract is signed, the seller may often choose to continue showing the property and accept a higher offer. Terms of the contract are very important and regulate all the details of the future purchase. You should carefully go over the contract with your lawyer to understand the risks and obligations you are taking upon yourself. Upon signing the contract, 10% deposit of the property price is payable. Therefore you have to make sure that you have the funds readily available in the US. One way to do it is to wire the funds to your attorney in the US. You may also open a US bank account if you wish. This deposit is kept in the seller s attorney-designated escrow account. It is usually non-refundable if a buyer doesn t go ahead with the deal. However, you can, negotiate certain conditions under which you can get the deposit back. One of such conditional is a mortgage contingency a clause in the contract that guarantees the refund of the deposit if a buyer cannot secure financing at certain terms. It is up to your lawyer to negotiate this clause with the seller, although few sellers agree to include it Step 4: Coop or Condo board approval Board approval is probably the most unpleasant part of a property purchase in New York. It is something that cannot be avoided even if you are buying an apartment in the friendliest of all condo buildings. You will have to put together a very thorough package with a lot of personal and financial information including tax returns, bank statements, personal and business references, etc. Coop board approval is a rigorous process that will usually include a personal interview. Condo board approvals follow the same procedure and require the same amount of documentation. However, it is usually a an easier deal. Step 5: Preparation and closing After the contract is signed, you have additional time to secure financing and perform additional research on the property s legal status and condition. This is the time to do the survey and appraisal, which is necessary for the mortgage. Your lawyer will be reviewing the documents, doing the title search, looking for liens and violations. If you apply for a mortgage, your bank will check all the required documents on your income and assets as well as the building financials. Once everything is in order, your bank will wire the entire amount of the loan usually to your attorney s escrow account. At the same time your down payment and final closing costs will also be wired to the escrow account with your attorney acting as an escrow agent until the closing. The day before your closing you should do a final walk-through at your new property to make sure its condition is as agreed and as expected.
5 Step 6: Closing A closing is an actual sale-purchase transaction, which usually takes place several weeks after signing the contract. This is the time when all the parties in the transaction (seller(s) and buyer(s), seller s and buyer s attorney, bank attorney, title insurance representative, etc,) gather together to sign a final set of documents and to make all the payments. At the moment of the closing, your attorney will distribute all the payments including the payment to the seller, taxes, fees and title insurance and other. In exchange a buyer will receive the new title along with the title insurance and, of course, keys to the new investment property. Congratulations! What will be my expenses as an owner of real estate in New York? As an owner of real estate property in the US, you will have to pay real estate taxes and monthly common charges for a condo and a monthly maintenance fee for a co-op. Depending on the type and the size of the property, taxes may run from a few hundred dollars a year to several thousand dollars per year. The same is true for common charges and maintenance fees these range from a couple of hundred a month to a few thousand a month and depend on the size and type of property as well as on location and amenities available. The more additional services the building offers, the higher the monthly payments. Be prepared to spend over $1 dollar per square foot per month for your property in New York. As an owner of your home, you can use some of these expenses to lower your tax bill. Real estate taxes can be deducted from taxable income by the owner (the person who actually paid real estate tax) within the same year. Owners of a co-op can deduct part of their monthly maintenance because it consists of, among other things, the interest payment on the co-op building mortgage. If you are an investor, most of your expenses can be deductible in the year they were incurred. Both common charges and real estate tax are treated as a business expense in the year incurred and can be deductible. Please consult your tax advisor if this applies to you. How do I check property title and make sure my purchase is legal and safe? To structure the sale-purchase transaction, both the seller and the buyer employ attorneys, who negotiate the contract (preliminary agreement, under which a deposit is paid), arrange for the title search and insurance, check for liens and violations on the building, etc. Other professionals that might be needed include appraisers, who determine the fair market value for the property; surveyors, who check the condition of the property and its technical elements; architects, who determine the exact size of the property and make measurements; and mortgage brokers, who help secure a mortgage loan. Michael Charles New York will be happy to recommend real estate attorneys, appraisers, mortgage specialists and other real estate professionals who will be able to help you with your purchase.
6 What are the taxes on sale proceeds for a non-resident? There is a significant difference in tax liability for foreign and US tax residents. Federal tax on long term (property held more then a year) capital gain for US residents is 15%. The same tax for foreign residents is 30%. Moreover, to insure payment of the U.S. tax, non-residents are subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding immediately upon sale of a property by a foreign resident. The Internal Revenue Service (IRS) withholds 10% of the gross sale price; New York State withholds an additional tax of approximately 6.85% of the Estimated Gain. An IRS form must be filed by the seller/buyer -Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. For New York State, an additional form must be filed -Nonresident Real Property Estimated Income Tax Payment Form (Complex form, please consult with a tax professional for completion). To avoid this complexity, in some cases it makes sense for a foreign buyers to own real estate through a domestic Limited Liability Company or LLC. What are Buyer s expenses at closing (Closing Costs)? Closing costs are an additional expense that both a buyer and a seller occur during a sale-purchase transaction. Closing costs in New York may comprise 1-8% of a purchase amount. Buyer s expenses include legal and registration fees as well as federal, state and city taxes. These costs have to be covered before or at the closing and will be an addition to your down payment. Please include these costs in preparation for your purchase. These expenses are described in detail below. If you are buying a newly built condo (in NYC it is called buying from a sponsor ), you might have to pay: New York City real property transfer tax, which equals 1% for properties below $499,999 and 1.425% for properties above $499,999. Another tax payable to the state is New York state transfer tax, which is 0.4% of the sale price. Additionally, you will have to cover the seller's attorney fee which is usually $1,500-$2,500. * Title insurance is also required to protect your ownership right from possible third party claims for the entire length of your ownership. It costs approximately $450 per $100,000 of the property price. * If your property costs more than $1,000,000, you will also have to pay a Mansion Tax of 1% of the property price.* Many buildings collect additional fees such as an application fee of $200 and up; a managing agent fee of $250-$500, and a move-in deposit of $500-$1500.* You will also have to hire an attorney to review all the documents. This amount can range from approximately $2,500-$5,000 depending on the complexity of the purchase structure plus recording expenses, starting at $500. * If you are taking on a mortgage to buy your property, more cash is needed for closing. Mortgage loan origination fees or points range from 0.5% to 3% of value of the loan. Such mortgage-related expenses include a lien search of around $300 -$400, various bank fees (such as tax escrow, homeowners' insurance) of $400-$1200, mortgage title insurance, which costs $200 per $100,000 of property value, and a mortgage tax of 1.8% of the mortgage loan for loans under $499,999 and 1.925% of mortgage loans above $499,999. Additionally, you will have to pay $500 and up for an appraisal, $30-$100 per applicant s credit report, another $500 and up for the loan application. There is also usually a bank attorney fee of approximately $1000-$1500.
7 What is a Condo building? Around 25% of the residential buildings in Manhattan are condos, and their number is rapidly growing. Condominium buildings (condos) are multiple family buildings where you own an apartment and a corresponding share of common areas a regular form of real estate ownership. Unlike in Co-ops, there are minimal restrictions for who can own a condo as well as on usage of a condo property. Condos welcome foreign investors, allow pied-a-terres (part-time stay) and using it as an investment property, which means that you can rent it out for as many years as you d like. To manage a building, condominiums usually also have a Board -an elective organ of owners that makes and approves important decisions on use, repair and internal rules that are mandatory for all owners and tenants in the building. There is also a formal approval process of each potential purchaser performed by the Board, however, such approval is a formality. Condos are priced higher than co-ops, mainly because of the higher liquidity of this type of investment. Simply put, condos are easier to buy and easier to sell than coops. As a result, condos are a more attractive option for buyers from abroad. There has been a lot of condo construction in New York over the recent few years. Many older buildings are undergoing renovation and are being converted to condos as well. In addition, most newly constructed condos offer tax relief for the first 10 to 25years, which results in significant tax savings. Moreover, many newly constructed buildings boast sleek modern amenities, floor to ceiling windows, mint renovation and superb services. How are property rights registered? A recording of the title with the new owner s information is part of the closing, and is usually carried out by the buyer s attorney, who submits the documents at the New York City Register. At the moment of purchase, all title documents are photographed, photocopied and filed so that they can be found and examined by everyone who wants to see them.
8 CLOSING COSTS FOR THE SELLER Broker as provided in exclusive with broker Own Attorney approx. $2,000 +/-, as negotiated Managing Agent s Fee...approx. $500 +, as determined by building Move-outout Deposit or Fee.approx. $1,000, as determined by building New York City Transfer Tax** 1% of entire gross purchase price, if price is $500,000 or under; or, 1.425% of entire gross purchase price, if price exceeds $500,000 New York State Transfer Tax...0.4% (.004) of gross purchase price Bank, Satisfaction of Mortgage Fees. approx. $450, as determined by bank Recording, ACRIS, other fees...approx. $150 Gains Tax Withholding (Out of State Seller)..8.97% of gain Non US Resident (FIRPTA)..10% of price withheld or paid Stock Transfer Tax (Coops Only).$0.05/share FOR THE PURCHASER Own Attorney...Approx. $2,000 +/-, as negotiated Bank Fees: application, credit, appraisal, bank attorney and miscellaneous.approx. $2,200, as determined by bank Short-termterm Interest.One month max (prorated for month of closing) Misc. Recording Fees* Approx. $500 Mortgage Recording Fee*/**.2.05% of entire amount of Mortgage on Loans $500,000 or under,; or, 2.175% of entire amount of Mortgage on Loans exceeding $500,000 Fee Title Insurance*.Approx. $8,000 for $2,000,000 NYC condo, based on rate schedule Mortgagee Title Insurance*..Approx. $1,500 for $1,500,000 NYC condo mortgage, based on rate Schedule Misc. Title Charges*...Approx. $500 Managing Agent s Fee Approx. $500, as determined by Building
9 FOR THE BUYER (cont d) Adjustments: Common Charges.. Approx. One month (prorated for month of closing) Real Estate Tax Escrow..Approx. 8 months (pro rated to closing, plus 6 month escrow, may include insurance) Mansion Tax 1% of entire gross purchase price, if purchase price exceeds $1,000,000 Move-in Deposit or Fee Approx. $1,000, as determined by building Lien Search (Co-ops Only) Approx. $350 * Mortgage Recording Tax and Title Insurance not required for Co-ops, though title insurance is available for Co-ops at other rates. ** For Bulk Sale, Multi Family and Commercial Property: NYC Transfer Tax Rates $1.425% under $500,000, 2.625% above; Mortgage Recording Tax Rates, 2.05% under $500,000; 2.8% above $500,000. When purchasing a condominium unit directly from a Sponsor, the Purchaser may be required to pay New York City and New York State Transfer Taxes (See For The Seller section above for amounts), as well as the Sponsor s attorney s fee (typically around $1,500). All costs are estimated, and will vary based on transaction specifics, changes in rates and taxes, and other factors. No representation is made as to the accuracy of these estimates. Parties to transactions must consult their own counsel and refer to transaction specifics for verification of all costs.