Partnerships and FIRPTA

A post on FIRPA in March 2010 generated a lot of interest and follow up email discussions. An exchange last week led me to do a bit more reading on it. The reader had been advised that transferring 3 rental properties under a partnership (LLP or LLLP) would have a few advantages most of which have been discussed here previously. The new idea was protection from a withholding under FIRPTA. Is that true?

Well yes and no. According to the IRS web site, "For cases in which a U.S. business entity such as a corporation or partnership disposes of a U.S. real property interest, the business entity itself  is the withholding agent.". 

The buyer has the obligation under FIRPTA to determine whether the seller is foreign or not.  If so, they withhold 10% and send it to the IRS.  So, if the seller is a partnership such as an (L)LLP then it looks like the buyer is off the hook and they don't need to withhold and submit the 10%.  However, according to that quote, the (L)LLP has that obligation.  So...theoretically, the withholding still happens...and the partnership would not protect you.  It's just that you (the partnership) do the submitting.

On the other hand, if the (L)LLP did not do the withholding as it is supposed to do...but you went ahead and paid the tax owed on the capital gains, would the IRS object to you not first sending the 10% and then getting a refund for the difference.  Maybe not. What do you think?