Helping a foreigner sell a U.S. house

Dear Tax Talk,
I do not live in the United States, nor am I a permanent resident or citizen of the United States. However, I currently own a five-bedroom house in Florida as a vacation home. I bought this house in 1999, used it when on vacation, and eventually rented it out through a real estate company for 2.5 years up until earlier this year. It is now empty and I want to sell it. What are the laws that apply to the fees and taxes that will apply to the selling price, considering it is a second home and I am not a U.S. citizen or resident?
-- Vivienne

First, you need to file Form 1040NR for the period the property was rented. You need to report the rental income and expenses for this 2.5-year period even though you may have not had any net income after all your expenses. If you don't have an individual taxpayer identification number, or ITIN, you need to apply for one when you file the Forms 1040NR. Use Form W-7 to apply for an ITIN, attaching it to the 1040NR forms and mailing all to the address in the ITIN instructions.

Apart from your closing costs on the sale, the buyer of the property is obligated to withhold 10 percent of the selling price as an estimate of U.S. income taxes due on the sale. The withholding can be reduced if you apply for a withholding certificate prior to the sale of the property but after you have a firm contract. The process for applying for the certificate requires you to present your anticipated tax liability based on the actual gain from the sale. Since the long-term capital gain rate applicable to the sale of property by an individual, including a foreigner, is 15 percent of the gain, chances are this will be less than 10 percent of the selling price. For example, if the sales price is $750,000 and the gain is $250,000 the required withholding is $75,000 but the actual tax is only $37,500.

To apply for the certificate, you need to complete and submit Form 8288-B prior to the closing. Since this form is particular to the contract with the buyer, it is usually not completed prior to the date you are certain you will close. If you don't close with that particular buyer, you need to reapply. Since the Internal Revenue Service will not process the certificate for 60 to 90 days, the buyer still has the obligation to retain the 10 percent until the application is processed. However, the 10 percent can be retained by the buyer in the closing attorney's escrow account rather than being sent in to the IRS.

After processing the certificate, the IRS will inform the attorney on how to disburse the withheld taxes. Having the attorney retain the funds in escrow will generally result in a faster return of the over-withheld taxes than if the money were sent to the IRS. But in order for the attorney to maintain custody of the funds, you have to apply for the certificate on or before the date of closing.

In my experience, the IRS has become more efficient in processing these requests and has streamlined the information required for the application. It is usually beneficial to have an accountant complete the necessary paperwork, and the follow up with the IRS is also very important after the sale. The Form 1040NR and W-7 should be done right away as they are not dependent on the sale.