US real estate tax can have a serious impact on the amount of profit made through the purchase and sale of property in the United States of America (USA). It’s a topic that all foreign investors need to understand in order to be invest successfully in the USA.
In total, a foreigner investor needs to consider three main areas when it comes to tax; income, capital gains and inheritance tax. The laws are quite complex and require a good international tax professional, but here is a brief overview.
- Income Taxes: If you end up renting your property, you will need to pay income tax. As a foreign real estate investor, you can simply choose to have the gross income taxed, currently at a rate of 30%. If you decide to go ahead with this basic flat rate, deductions for things such as maintenance, mortgage interest and utility payments are not permitted.. Nevertheless, your country may have special treaties with the USA where the flat rate is actually less than 30%.
A better, and more popular alternative, is to treat investments in US real property as a trade or business. This allows you to be taxed on net income rather than gross, which can greatly reduce your US Real Estate Tax bill.
- Capital Gains Tax: When you sell your real estate, capital gains tax is due. In order to ensure compliance with payment, the US government has established FIRPTA which stands for Foreign Investors Real Property Tax Act. It requires certain purchasers’ agents, and settlement officers to withhold 15% (10% for dispositions before February 17, 2016) of the amount realized on the disposition (special rules for foreign corporations). Once a return is filed, the money is used toward the taxes owed, or refunded if necessary.
There are some instances where FIRPTA does not apply. Generally you do not have to withhold in the following situations; however, notification requirements must be met:
- You (the transferee) acquire the property for use as a residence and the amount realized (sales price) is not more than $300,000. You or a member of your family must have definite plans to reside at the property for at least 50% of the number of days the property is used by any person during each of the first two 12-month periods following the date of transfer. When counting the number of days that the property is used, do not count the days the property will be vacant. For this exception, the transferee must be an individual.
- The property disposed of is an interest in a domestic corporation if any class of stock of the corporation is regularly traded on an established securities market. However, this exception does not apply to certain dispositions of substantial amounts of non-publicly traded interests in publicly traded corporations.
- The disposition is of an interest in a domestic corporation and that corporation furnishes you a certification stating, under penalties of perjury, that the interest is not a U.S. real property interest. In most cases, the corporation can make this certification only if either of the following is true.
- During the previous 5 years (or, if shorter, the period the interest was held by its present owner), the corporation was not a USRPHC.
- As of the date of disposition, the interest in the corporation is not a U.S. real property interest by reason of section 897(c)(1)(B) of the Code. The certification must be dated not more than 30 days before the date of transfer.
- The transferor gives you a certification stating, under penalties of perjury, that the transferor is not a foreign person and containing the transferor’s name, U.S. taxpayer identification number, and home address (or office address, in the case of an entity).
- The transferor can give the certification to a qualified substitute. The qualified substitute gives you a statement, under penalties of perjury, that the certification is in the possession of the qualified substitute. For this purpose, a qualified substitute is (a) the person (including any attorney or title company) responsible for closing the transaction, other than the transferor’s agent, and (b) the transferee’s agent.
- You receive a withholding certificate from the Internal Revenue Service that excuses withholding. See Withholding Certificates , later.
- The transferor gives you written notice that no recognition of any gain or loss on the transfer is required because of a nonrecognition provision in the Internal Revenue Code or a provision in a U.S. tax treaty. You must file a copy of the notice by the 20th day after the date of transfer with the Ogden Service Center, P.O. Box 409101, Ogden, UT 84409.
- The amount the transferor realizes on the transfer of a U.S. real property interest is zero.
- The property is acquired by the United States, a U.S. state or possession, a political subdivision, or the District of Columbia.
- The grantor realizes an amount on the grant or lapse of an option to acquire a U.S. real property interest. However, you must withhold on the sale, exchange, or exercise of that option.
- The disposition is of an interest in a publicly traded partnership or trust. However, this exception does not apply to certain dispositions of substantial amounts of non-publicly traded interests in publicly traded partnerships or trusts.
- Inheritance Tax: If you die owning property in the US, your estate will have a hefty inheritance tax burden. Foreign individuals are not allowed the usual exclusion given to US residents. However, you can avoid this tax by establishing entities offshore to own the property.
Can I Buy US Property As a Resident or Non-Resident Alien?
It is fairly easy for foreigners to purchase real estate in the USA, regardless if they are residents or non-resident aliens. While purchasing the property may be easy, how you purchase the property can have long-term tax implications that some property owners are not prepared for.
Before you purchase property, it is important to consider exactly who will be purchasing the property and how the property will be used, these two factors can affect the type of taxes you are subjected to under US tax codes.
Who is Purchasing the Property?
There are several different entities that can purchase property and each one is governed by different tax codes. If you are considering purchasing property in the United States, you should talk with a tax professional who specializes in tax law in order to make sure that you chose the best entity to purchase your property.
- Direct ownership is when an individual purchases a property directly. Direct ownership is the most straightforward way of purchasing a property, but non-resident or resident aliens might be subjected to large estate taxes that they aren’t prepared for when transferring or passing on the property.
- Corporations- Partnerships or corporations can also purchase real estate. The corporation can be a foreign one or a foreign-owned domestic one, but it must be able to prove its validity to the IRS. There are tax benefits of a corporation or a partnership owning a property, including the possibility of avoiding a future estate tax and federal income tax. While buying through a corporation can limit tax liability, transactions can be complicated. It is important to know that tax laws apply differently to foreign and domestic corporations.
- Trusts- A trust is also able to purchase a property. Trusts can help avoid later surprise estate taxes, but they must be executed properly in order to maintain their tax code status.
How will the Property be Used?
The second issue to consider when you are purchasing real estate in the United States as a non-resident or resident alien is how you will use the property. Are you planning on using it as a residence for you or your family members, or are you planning on renting it out? In order for a foreigner to classify a home as a residence, US tax codes state that they must reside there 50% of the time over the course of a two-year period. Properties that are considered corporate holdings or rental properties are governed by different tax codes than private residences.
While it may be relatively easy to purchase property in the United States as a non-resident or resident alien, how you purchase the property will have long term financial implications. Working with a tax professional who specializes in real estate tax law can help you chose the best way to purchase your property so that you are aware of pertinent tax codes and future taxation.
There exist certain investment structures which can be put into place to help reduce or eliminate the amount of tax paid. The key is to find a skilled International tax professional, and discuss the US Real Estate Tax, as well as the pros and cons of each structure, prior to investing in the market.