IRS to Do More to Ensure Tax Compliance on Foreign Investments in Real Property

The Internal Revenue Service plans to take additional actions to improve taxpayer compliance with a law related to the disposition of foreign investments in U.S. real property, according to a new government report.

The report, from the Treasury Inspector General for Tax Administration, noted that Congress passed the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) to provide federal tax rules for the sale of U.S. real property by foreign persons. The Deficit Reduction Act of 1984 imposed a withholding tax on the anticipated taxes due on any capital gain from the sale of a U.S. real property interest by a foreign seller. This is generally the only method that the IRS has to ensure the collection of any taxes on the capital gains resulting from these sales.

Once the foreign seller and the sale proceeds leave the United States, it is difficult for the IRS to collect any delinquent taxes due, TIGTA noted. When this happens, the foreign sellers may be able to evade payment of taxes.

“TIGTA found that there are some barriers for the IRS in ensuring the tax compliance of real estate sales transactions subject to the FIRPTA,” said TIGTA Inspector General J. Russell George in a statement. “As such, the IRS cannot provide assurance that all foreign seller real estate transactions comply with this law.”

TIGTA’s review of Form 1099-S, Proceeds From Real Estate Transactions, real estate transaction data reported to the IRS revealed that there may be noncompliance with the FIRPTA filing requirements. TIGTA also found that the IRS did not always ensure compliance with FIRPTA filing requirements when a request for reduced withholding was filed and the FIRPTA withholding tax was still owed.

In addition, TIGTA also identified various internal control weaknesses in the processing of FIRPTA withholding payments and FIRPTA withholding credits claimed by foreign sellers on their income tax returns.  These internal control weaknesses led to the issuance of erroneous tax refunds and balance due notices.

TIGTA made several recommendations to improve compliance with the FIRPTA, including revising the Form 1099-S to more easily identify real estate transactions subject to this law and considering legislative/regulation changes to reduce barriers to effective administration of the FIRPTA. TIGTA also made several recommendations to improve controls over the processing of FIRPTA transactions.

The IRS agreed with four recommendations and indicated it had already addressed a fifth recommendation, which TIGTA said it was unable to verify. The IRS said it would apprise the Treasury Department of the recommendation pertaining to overcoming barriers to ensuring taxpayers comply with the FIRPTA. However, it did not agree to one recommendation intended to help it validate affidavits of non-foreign status. TIGTA said it continues to believe that the IRS should follow through on this recommendation.

The IRS also pointed out that TIGTA’s report did not cover the full range of its FIRPTA compliance activities.

“We agree that there are some barriers to effective enforcement of FIRPTA, and that improvements to our processing controls would help to ensure that erroneous refunds and balance due notices are not issued,” wrote Heather Maloy, commissioner of the IRS’s Large Business and International Division, in response to the report. “We note that the focus of this audit was primarily on compliance with FIRPTA as it pertains to real estate transactions involving individuals, and while that represents a significant number of transactions, the FIRPTA compliance universe is also significantly impacted by real estate transactions involving businesses.”