Refunds of the Excess Withholding Tax/ 8288-B Withholding Certificates
Non- US sellers of US real estate are subject to a withholding tax at time of sale (generally 15% gross sales price). But we know 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 for the real tax owed from their home in Shanghai). In 98 or 99 out of 100 instances , the withholding tax amount 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%). Take the following example:
Example. Chinese citizen-residents Jimmy and Cindy bought a Los Angeles house a few years ago for $1,000,000, and on January 15, 2019, they sell it for $1,200,000. Because Jimmy and Cindy are not US persons, the escrow company overseeing the sale must send $180,000 ($1,200,000 sales price x 15% withholding tax) into the IRS at close (January 15, 2019). But the actual tax they owe really is only around $30,000 ($1,200,000- $1,000,000 =$200,000 profit, x the general capital gains rate of 15%= $30,000 actual tax owed). So as of January 15, 2019, the IRS will hold $150,000 of real estate sale proceeds which really belong to sellers Jimmy and Cindy. So when will Jimmy and Cindy receive their $150,000 refund?
The timing of the refund of the excess withholding tax possibilities are:
- The Normal Refund Time – The normal refund time process requires foreign sellers to submit one-time US tax returns the calendar year after the sale, but will also require several proper steps taken by the non-US sellers to piece together the ability to procure their refund from the IRS (the refunds from the IRS are not so easily obtains, this process is trickier than it may appear). But assuming the sellers (Jimmy and Cindy in our example above) take these proper steps, they will receive their refund around the middle of the next calendar year after the year of sale (say July 2020 using the example above). While this may seem like a long time (18 months after close of sale) to wait for their refund, Jimmy and Cindy will be somewhat fortunate simply to receive their refund at all.
- The 8228-B Option: the Quickest Possible Refund – Foreign sellers can apply for an early refund (or really an early release) of the excess withholding tax by preparing (via experienced tax professionals such as DIRECTS) an IRS Form 8288-B Application (which will prove to the IRS the seller made only $200,000 profit in our example, and really only owe the IRS $30,000 in tax, and are therefore owed a refund of $150,000 by the IRS). If completed properly (and again, this will require several proper steps taken by the non-US sellers, this is not easy stuff) the sellers will receive their refund when the IRS issues a withholding certificate around four months after sale (or around May 2019 in our example above… by utilizing the 8288-B process and obtaining a withholding certificate, Jimmy and Cindy receive their $150,000 refund well over a year earlier than they would have in the Normal Refund Time).
- Careful- Many Non-US Sellers Will Never Receive Their Refund – Many foreign sellers will simply be unable to obtain their refund. Again, many proper steps must be taken by the foreign sellers to obtain a refund. If the seller does not take the proper steps, the IRS will simply keep the excess withholding tax. It is hard to say what percentage of non-US sellers never receive their withholding tax refund, but a guess is a significant minority of all foreign seller never receive their refund. This is where experienced tax professionals like those at DIRECTS are crucial. A foreign seller is in many ways a winner just to receive their refund at all.
- Non-US Sellers Will Have Around 3 to 4 Years After Sale to Successfully Receive Their Refund; so Refunds for Prior Year’s Sales Remain Available for Years After Sale. If in our example above the sale took place in 2018 instead of 2019, the refund would likely still be available to the non-US seller. But soon the IRS’ statute of limitations will prohibit the foreign seller from receiving any refund. So non-US sellers will have more than one year after the sale to obtain their refund, and they should apply for their refunds for prior year sales (but again, they will need sophisticated help, such as from DIRECTS to obtain the refund from the IRS).