Foreign investment in U.S. real estate sits at the intersection of three tax regimes that most investors encounter separately but that are deeply interconnected in practice. FIRPTA governs when gain from the sale of U.S. real property is taxable to a foreign person — and who is responsible for withholding. The USRPHC rules extend FIRPTA's reach from direct property ownership to stock sales. And Section 351 determines whether a foreign investor can contribute appreciated property to a U.S. corporation without triggering immediate tax — with important caveats that interact directly with the first two regimes. Understanding how these three concepts work together is essential for any foreign investor structuring or exiting a U.S. real estate position.

FIRPTA: The Withholding Regime for U.S. Real Property

The Foreign Investment in Real Property Tax Act — enacted in 1980 and substantially amended since — subjects foreign persons to U.S. income tax on gain from the disposition of a "United States real property interest" (USRPI). Before FIRPTA, the general rule was that foreign investors owed no U.S. tax on capital gains unless they were engaged in a U.S. trade or business. Real estate was the exception Congress chose to address first.

A USRPI includes any direct interest in U.S. real property — land, buildings, and improvements — as well as any interest in a domestic corporation that constitutes a U.S. Real Property Holding Corporation (discussed below). When a foreign person sells a USRPI, the gain is treated as income effectively connected with a U.S. trade or business and taxed at ordinary graduated rates, not the preferential capital gains rate available to U.S. persons on long-held property.

Withholding mechanics. The buyer in any USRPI transaction is the withholding agent. The default rate is 15% of the gross amount realized — not 15% of the gain. This distinction is significant. If a foreign seller acquired a Miami condominium for $600,000 and sells it for $800,000, the buyer is required to withhold $120,000 (15% of $800,000) and remit it to the IRS at closing. The seller's actual tax on the $200,000 gain, at long-term capital gains rates, might be substantially less — but the withholding obligation is calculated on the sale price regardless.

A reduced rate of 10% applies when the buyer acquires the property for use as a residence and the amount realized is between $300,000 and $1 million. No withholding is required if the buyer acquires the property for use as a residence and the amount realized does not exceed $300,000 — a provision designed to avoid burdening small residential transactions.

The withholding certificate. A foreign seller who believes the statutory withholding amount exceeds the actual tax liability can apply for a withholding certificate from the IRS before closing. The IRS reviews the application and issues a certificate authorizing reduced withholding based on the estimated maximum tax. The process typically takes 90 days, so sellers who intend to apply must start well before the closing date. A seller who waits until the week before closing has no realistic path to a withholding certificate and will need to file a tax return to recover the overage after the fact.

Key exceptions. FIRPTA withholding does not apply to dispositions by a "domestically controlled" qualified investment entity (such as a REIT where less than 50% of the fair market value of the stock is held directly or indirectly by foreign persons), interests in publicly traded entities where the seller held 5% or less of the class of interest being sold, and certain distributions from REITs to foreign investors that meet specific criteria.

USRPHCs: When Stock Sales Trigger FIRPTA

Left unconstrained, FIRPTA could be avoided by holding U.S. real property through a domestic corporation and selling the stock rather than the property. Congress addressed this through the U.S. Real Property Holding Corporation (USRPHC) rules, which treat an interest in a USRPHC as a USRPI — meaning a foreign person selling stock of a USRPHC is subject to FIRPTA withholding just as if they had sold the underlying property directly.

The 50% test. A domestic corporation is a USRPHC if the fair market value of its U.S. real property interests equals or exceeds 50% of the sum of: (i) its U.S. real property interests, (ii) its interests in real property outside the United States, and (iii) any other assets used or held for use in a trade or business. The test is a balance-sheet snapshot at fair market value, not book value, which means a corporation that was not a USRPHC when formed may become one as its real estate holdings appreciate relative to other assets.

The five-year lookback. The USRPHC rules include a lookback provision: a corporation is treated as a USRPHC if it was a USRPHC at any time during the shorter of (i) the five-year period ending on the date of the sale or (ii) the period during which the taxpayer held the interest. This prevents a simple pre-sale restructuring from eliminating USRPHC status acquired during the holding period.

The publicly traded exception. Stock of a domestically controlled publicly traded corporation is not treated as a USRPI if the selling foreign person holds 5% or less of any class of stock regularly traded on an established securities market. This exception has real planning significance for foreign investors in public REITs and real estate operating companies — but it does not help private investors in closely held corporations.

Practical implications for private investors. A foreign family that holds a portfolio of Miami condominiums through a U.S. LLC or corporation may be holding stock or membership interests in a USRPHC without knowing it. When a family member wants to sell their interest, the buyer is required to withhold 15% of the amount realized on the stock sale — the same obligation that would apply to a direct property sale. Advisors structuring exit transactions for foreign investors should analyze USRPHC status before the transaction, not after the closing documents are signed.

Section 351 Exchanges: Contributing Property to a Corporation

Section 351 of the Internal Revenue Code provides that no gain or loss is recognized when property is transferred to a corporation solely in exchange for stock, provided the transferors are in "control" of the corporation immediately after the exchange. Control means ownership of at least 80% of the total combined voting power and at least 80% of the total number of shares of each class of nonvoting stock.

The nonrecognition rule exists because a contribution to a controlled corporation is viewed as a continuation of the investor's ownership interest in a different form — not a realization event. The basis carries over: the transferor's basis in the stock received equals the basis in the property contributed (adjusted for any gain recognized), and the corporation steps into the same basis in the property.

Boot. If the transferor receives anything other than stock — cash, debt relief, or other property — that "boot" is taxable to the extent of any gain realized. A foreign investor contributing a $1 million building with a $400,000 basis to a corporation in exchange for $900,000 of stock and $100,000 of cash has realized a gain of $600,000 but recognizes only $100,000 — the amount of boot received. The remaining $500,000 is deferred into the basis of the stock.

Where Section 351 intersects with FIRPTA. The contribution of a USRPI to a domestic corporation under Section 351 is itself a "disposition" for FIRPTA purposes. However, the IRS has generally taken the position that FIRPTA does not apply to a Section 351 exchange if the foreign transferor receives only stock of a domestic corporation — because the USRPI interest is exchanged for an equivalent form of investment (stock of a USRPHC) rather than cashed out. The nonrecognition treatment survives, but the foreign investor now holds stock of what is likely a USRPHC, and any future sale of that stock will trigger FIRPTA.

The Section 367 overlay further complicates the analysis when a U.S. person contributes appreciated property to a foreign corporation in a transaction that would otherwise qualify for Section 351 nonrecognition. Section 367(a) generally requires the U.S. transferor to recognize gain on such a contribution — treating the transfer as a taxable sale — unless the taxpayer enters into a gain recognition agreement (GRA) with the IRS, which defers the gain subject to a five-year monitoring period and triggers recognition if the foreign corporation disposes of the property.

The planning takeaway. Foreign investors considering a Section 351 contribution of U.S. real property to a U.S. corporation should understand that the contribution may be FIRPTA-free at the time of contribution, but the resulting stock will be a USRPI that triggers withholding on future sale. The contribution defers the FIRPTA exposure — it does not eliminate it. Structuring the exit from the outset, rather than as an afterthought, is the only way to manage all three regimes in a coherent plan.