Options are real estate, too
June 6, 2005 - Phil HodgenUS Real Estate InvestmentsHot off the press! There’s a new legal memorandum from the IRS about sale by a nonresident of an option to acquire U. S. real estate. Link to the full text below.
PHIL’S EDITORIAL COMMENTS
Federal tax laws say that when a nonresident disposes of a “U. S. real property interest” there is tax to pay [go see Internal Revenue Code Section 897]. Also, the buyer must withhold 10% of the purchase price [go see Internal Revenue Code Section 1445].
So let’s say a nonresident acquires an option to buy U. S. real estate. In a fit of speculative fervor, the nonresident later sells the option (at a profit or not). The nonresident never actually acquires the real estate.
Questions: Is the sale of the option taxable? Must the buyer withhold 10% of the price?
Answers (per the IRS): yes to both.
Comments (from me): Duh. The IRS is right. Why was this even a debatable point?
IRS LEGAL MEMORANDUM
The IRS Chief Counsel’s office has issued a legal memorandum saying that the transfer of an option on real estate triggers the withholding requirements. Full text after the jump.
Release Date: MAY 02, 2005
UILC: 1445.00-00, 1445.01-00, 897.00-00, 897.02-00
to: Mr. Fred Dulas
Revenue Service Representative
(Large & Mid-Size Business)
from: Mr. Robert W. Lorence, Jr.
Senior Counsel, Branch 4
Office of Associate Chief Counsel (International)
subject: Transfer of Options to Purchase Real Property by
Foreign Persons
Under section 897(c)(1)(A)(i), a U.S. real property interest includes an interest in real property located in the United States. Section 897(c)(6) provides that an interest in real property includes “. . . options to acquire land or improvements thereon, and options to acquire leaseholds of land and improvements thereon.” Treas. Reg. section 1.897-1(d)(2)(ii)(B) provides “an option, a contract or a right of first refusal to acquire any interest in real property (other than an interest solely as a creditor) will itself constitute an interest in real property other than solely as a creditor.” As a result, an option to acquire an interest in real property located in the United States is itself a U.S. real property interest subject to tax under section 897 upon its disposition.
Treas. Reg. section 1.1445-1(b)(3)(iii) provides that the transferee of an option to acquire a U.S. real property interest must deduct and withhold a tax equal to 10 percent of the amount realized by the foreign transferor upon the disposition. (Section 1.1445- 1(b)(3)(iii), however, does not require withholding upon the initial grant of an option). Thus, the withholding tax under section 1445 applies when a foreign transferor sells an option to another person for consideration. Under section 1461, transferees of the options are liable for the tax if they fail to withhold.
Please call Tracy Perry at (202) 622-3860 if you have any further questions.
Robert W. Lorence, Jr.
Senior Counsel, Branch 4
Office of Associate Chief Counsel (International)