Foreign Investors in USA Real Estate

The tax laws on overseas investors in US real estate are quite difficult to understand. Make sure you contact me to get competent professional advice before even make a simple investment such as a vacation home. The following is a brief overview.

Goals of the Foreign Investor
The prospect of significant economic gain is perhaps the strongest lure of the foreign investor to U.S. real property. Historically, U.S. real property has been recognized as a strong investment, which has demonstrated steady appreciation without the fluctuations that are characteristic of the financial markets. The political and economic stability of the U.S., the absence of threat of government appropriation or nationalization, and the soundness of the currency system have no doubt lured investors. Satisfied with the safety and security of a U.S. real property investment, the foreign investor focuses attention on the impact of taxes, and desires:
1.Minimization of U.S. taxes on income from operating the property and on the gain from eventual disposition.
2. Avoidance of U.S. estate taxes on the U.S. assets of the foreign investor.
3. Minimization of foreign taxes on the U.S. business, including taxes associated with any current return on the foreign investor's debt/equity investment in the U.S.
From a non-tax perspective, the foreign investor wishes to shield his or her other assets from liabilities arising from U.S. investments. Additionally, foreign investors often desire anonymity both in the U.S. and in their home countries.
The investment structure needed to achieve one particular goal may conflict with the objectives of another. For example, direct ownership of U.S. real property would result in lower individual income tax rates, but would sacrifice anonymity and create the imposition of U.S. estate taxes. Accordingly, the proper structure for a particular situation will depend on the weight the foreign investors place on each of their goals.

U.S. Taxation on the Foreign Investor

Income taxes
If you rent out your real estate investment your income will be taxed.

1. You can elect to have the gross income taxed at a flat rate or file a tax return. The flat rate will be at 30% (but you may get some help from tax treaties to prevent taxation twice on the same income). The flat rate option will not allow you to deduct expenses such as maintenance, mortgage interest, electricity or water. The US person who withholds the tax must file an annual Form 1042 and 1042S.

2. Or it can be taxed as effectively connected US source income. Then you will have to file a 1040NR tax return but will be able to deduct for expenses associated with that income. This option is the sensible choice unless the income you generate is very low.

3. Under US tax law, you can depreciate the property, there are different rates for residential and commercial properties. This annual depreciation is deducted from your income as an expense on your tax return. But it will be recaptured when you sell.

4. If you invest in mortgages secured on US properties, your income will also be subject to tax. This would be subject to tax treaties that are intended to avoid double taxation. If the lender is from a country that does not have a tax treaty with the United States, withholding tax should be deducted at the appropriate rate, usually 30%. However it is possible for mortgage income to be characterized as portfolio income that is not subject to withholding tax.

Capital gains taxes

Unlike many countries, such as the UK, the US government also wants it's share, or more than its share, when you sell the real estate.
There is a new law called FIRPTA. (Foreign investors real property tax act.) The US government is very worried you will sell the property and skip the country with the money. Under FIRPTA, the US persons handling the transaction is required to withhold 10% of the GROSS price, even if you have not made a profit. It is possible to get an advance clearance from the IRS, but allow several months.
There is an exclusion to this, which the closing agent may not be aware of. That is if the property is sold for less that $300,000 AND the buyer (or family member) is going to use it as a personal residence. See the Act for the exact requirements. Then no withholding tax need be deducted. But you will still have to pay capital gains tax if it is owing.
The rate of capital gains tax is is slightly higher on the re-captured depreciation element of your gain.
If FIRPTA applies you can reclaim any excess deducted by making application to the IRS. Again allow several months.

Estate taxes

Variously known as death tax, inheritance, capital transfer taxes. Here the non-resident gets far worse treatment than the US citizen or permanent resident.
The US citizen has a 100% allowance on bequests and gifts to their spouse and very generous limits on transfers to other parties.
But this drops to just $60,000 if you are a foreigner who dies while owning US situs real estate. There may be some sort of relief through double tax treaties.
The estate taxes also apply to mortgages secured on US properties.

The above is intended to be accurate but is not guaranteed or intended to replace competent legal and tax advice from professionals in this field

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