Remember the old science-fiction movie where things that look like giant pea pods descend on Earth and overnight they grow into the shape of human beings? Remember how the hero wakes up and he's surrounded, not by neighbors and family, but by…aliens?
Could it really happen? Congress apparently thinks so. Ever alert to the slightest threat to life, liberty, and property, our far-sighted leaders in Washington want us to be ready in case the dreaded pea-pod people should arrive. And to prepare the populace without undue alarm, Congress is using the Internal Revenue Code.
It seems that them thar' foreigners used to be exempt from our capital-gains tax, and they've been accustomed to "gobbling up" our land, selling out at a profit, and paying no tax. Well, the law's been changed so that the capital gains of foreigners ("non-resident aliens," according to the IRS) are fully taxable. However, not enough of them have been paying attention to our laws. Terribly rude of them. But fear not.
Since January 1, 1985, those aliens are subject to a flat 10 percent withholding tax on their real-estate sales. Serves them right, huh? I mean, how dare they come here to the land of the free and offer us their money?
But who does the withholding? Good question. The answer is…you do.
The way it works is this: If you're the buyer of real estate, or of a corporation that owns real estate, you can't just fork over the purchase price to the seller. After all, he (or it) may be an alien. You have to hold back 10 percent (not 10 percent of the cash part of the deal but 10 percent of the entire purchase price) and send it to the IRS. You give a form (8288-A) to the seller showing what you've withheld, and you send copies of that, plus another form (8288), to the feds within 10 days of the transaction to tell them what's happened. The poor seller staggers away from the closing with nothing to show for it but a fistful of forms, and then he works out his tax liability or his refund with the feds. It's similar in concept to withholding income taxes from your employees.
What if you don't withhold the 10 percent? That's a real problem, because in all likelihood (says Congress) the seller's going to dash back to Denmark, or Argentina, or Mars, or wherever he came from, and he's not going to pay any taxes to the IRS. Before 1985, that was Uncle Sam's problem, but not any more. Now who pays if the foreigner doesn't? You do, dearie. That's right—you're personally liable for the 10 percent, and probably so are your agents (your lawyer, your broker, your escrow agent, etc.). And of course, there are penalties for failure to withhold; and there's always interest.
Are there any exceptions? Dumb question. How else would lawyers make a living if we didn't have exceptions? The withholding requirement doesn't apply if you're buying the property for use as your own residence and if the price is $300,000 or less. It also doesn't apply if the seller gives you an affidavit that he's not a foreigner. The feds have thoughtfully drafted a sample affidavit for you. But in the absence of receiving a "non-foreign affidavit" (or in the absence of some other exceptions too complicated to explain here), you've got to send 10 percent of the whole deal to Uncle Sam.
Consider a simple transaction. You're buying a parcel of nonresidential real estate, or maybe it's intended to be your residence but the price is over $300,000. The seller may be from a family that's owned that land for 200 years, he may be whistling "Yankee Doodle," and he may look like something out of a Norman Rockwell painting, but don't be lulled by any of this. The seller could be one of those alien creatures. Demand a non-foreign affidavit, and if you don't get one, take 10 percent of the deal and send it to the IRS.
Of course, the seller may look like a Pygmy, he may be wearing a loin cloth and carrying a blow-gun, and he may speak not a word of our language—but if he hands you a nonforeign affidavit, you're safe. He's one of us, and no withholding is necessary.
There's a sad aspect to all this, and it's not that Congress has been watching the late-late show too often. The really tragic side of this new law (section 1445 of the Internal Revenue Code, by the way) is that once more, each of us has been conscripted to do Uncle Sam's dirty work. And if an innocent American buyer, acting in good faith and understandable ignorance, acquires land from someone who does indeed turn out to be a tax-dodging foreigner, it's the American buyer who gets stuck. Life was easier (and we were freer) when we didn't tax foreigners' capital gains.
But why am I complaining? Don't I as a lawyer benefit from complicated laws? Indeed I do; but even so, why shouldn't I complain? It's a living, of course, but just like you, I'd be a lot better off if the whole tax system were junked. On that happy day of economic liberation there'll be a lot more savings, investment, commerce, and prosperity in the country, and that would benefit all of us—even tax attorneys.
But until then, the next time you buy some real estate—or stock in a corporation that owns real estate-you'd better demand that nonforeign affidavit. And when you go to sleep tonight, check under your bed. A giant pod may lurking there.
Warren Salomon is an attorney and tax specialist practicing in Miami.