22nd Annual Accounting Show

Transcription

1 FOREIGN INVESTMENT IN U.S. REAL PROPERTY FROM PURCHASE TO DISPOSITION Miguel G. Farra, CPA, JD Jeffrey Blinn, CPA, JD Erick R. Wendelken, CPA 1001 Brickell Bay Drive, 9 th Floor Miami Florida Telephone: Fax: nd Annual Accounting Show

2 Agenda Purchase, operation and disposition of U.S. real property interests By non-resident aliens, foreign corporations, foreign partnerships and foreign trusts Subject to U.S. income and estate and gift tax principles (planning and compliance) All section references are to the Internal Revenue Code of 1986, as amended or to the Treasury Regulations

3 Why is this Important? We have foreign clients with domestic real estate holdings or real estate professional clients that have significant dealings with foreigners investing in U.S. real estate. Our foreign clients generally want to benefit from investment in U.S. assets at the lowest possible overall U.S. tax burden. Foreign investment in U.S. real estate is subject to income, estate and gift tax.

4 Outside Scope of Presentation We will not discuss following principles that are equally applicable to non-u.s. and U.S. holders of U.S. real estate: a) )Passive Activity it Loss Rules b) Capitalization rules of sec. 263A c) Sec. 266 election to capitalize taxes/carrying charges d) Investor vs. Dealer status e) Real Estate Investment Trusts f) Requirements of simultaneous/non-simultaneous like-kind kind exchanges

5 U.S. Real Property Interests At issue is investment in U.S. Real Property Interests (USRPI). U.S. Real Property Interests t include the following located in U.S. (or USVI) if the interest is other than solely as a creditor (sec. 897(c)): a) Land, improvements, and unsevered ered natural resource rce interests. (We will not discuss natural resource issues) b) Condominiums c) Leasehold of land or buildings d) Associated personal property e) Stock of A U.S. corporation where at least 50% of its value is attributable to USRPI (a USRPHC) f) Option, contract, or right of first refusal to acquire an interest in the above (see IRS Fact Sheet )

6 General Principles The transfer of a US Real Property Interest by a foreigner is subject to U.S. income taxation (sec. 897); which is generally enforced by the application of a 10% withholding tax (sec. 1445). A foreign decedent s USRPI is subject to estate tax (sec et seq.), including stock of a USRPHC. A foreigner s gift of a USRPI that is real property is subject to gift tax (sec. 2501). Gift of stock of USRPHC is not subject to gift tax (unless expatriation rules apply).

7 What is not a USRPI Real property interest solely as a creditor (sec (d)). Interest is solely as a creditor if the foreign holder does not have any right to share in the appreciation in value of, or the gross or net proceeds or profits generated by, the real property (sec (d)(2)). 1(d)(2))

8 Interest Solely as a Creditor Debt that qualifies as Portfolio Debt under sec. 871(h), 881(c). Security interest (eg, right to repossess or foreclose) in USPRPI (sec (d)(2)(ii)(C)) 1(d)(2)(ii)(C)). Interest rate tied to measurement of inflation or deflation (sec (d)(2)(ii)(D)). Fees (commission, o brokerage, placement e of financing) if based upon a percentage of the purchase price or rent; but cannot be based upon appreciation, proceeds or profits occurring after the date of the transaction with respect to which the service was rendered (sec (d)(2)(ii)(E)). 1(d)(2)(ii)(E)) Trustee/Estate Fees even if the assets of the estate or trust include USRPI so long as fees are reasonable (sec (d)(2)(ii)(F)). Installment note from disposition of USRPI if had elected out of installment sale treatment (sec (d)(2(ii)(A)).

9 Purchase of US Real Property Can be purchased by: a) Foreign individual (alone or jointly) b) Entity US or not - belonging directly or indirectly to foreign individual (eg, US LLC or BVI entity) c) Foreign Trust Any ypurchaser must withhold 10% of the purchase price of the USRPI under sec unless the seller is: a) a tax resident of U.S. (eg, filer of Form 1040 or 1120) b) a U.S. trust, U.S. estate or U.S. partnership c) a foreigner who prior to sale provides notice that t a Withholding Certificate t was requested from the IRS; but place 10% in escrow. d) a foreigner selling the property for no more than $300,000 for use by the purchaser as a residence. Consider obtaining a Certificate of Non-Foreign Status from the Seller that is a U.S. tax resident, U.S. trust, U.S. estate or U.S. partnership and retain it at least until the end of the fifth year following the year of transfer (sec ) 2).

10 Operation of US Real Property Real Property may be held for: a) Use as a residence (not income producing). b) Investment (income producing).

11 Use as a Residence by NRA Generally, no tax forms to file other than property tax; and if held in Florida, generally not eligible for homestead protection. Consider whether the frequency of owner s use may result in owner becoming a US tax resident under the Substantial Presence Test (SBT) of sec. 7701(b)(3). If foreign owner is not a US tax resident, but is otherwise required to file the Form 1040 NR, not allowed to deduct the personal mortgage interest, property tax or other costs of the personal use property on the Form 1040NR.

12 Use as Investment Income Generating Rent earned by foreign individual/entity is generally taxed on the gross basis by the U.S. as passive income subject to sec. 1441/1442 withholding at 30% rate unless a lower treaty rate may be properly claimed through providing a W8-BEN to tenant. Foreign individual, trust or corporation may elect to be taxed on the net basis under sec. 871(d)(foreign individual/trust) or sec. 882(d)(foreign corp.). Attach election to, and annually file, Form 1040NR or 1120-F(F-1120). Provide W8-ECI to tenant to excuse withholding on rent payment. Florida imposes sales tax (7%- Miami Dade County) on the rent commercial real property.

13 Use of NOLs Deductible expenses may exceed income resulting in annual losses. Such losses from years prior to a year of sale would reduce taxable gain if available. Losses are utilizable only if return had been filed (secs. 874, 882(c)(2)) Returns may not have been timely filed for prior years, and their filing at a later date may be otherwise barred by IRS regulation (sec (a)(3)). Case of Swallows Holding (126 TC 96, Jan. 26, 2006) holds that prior year returns may be filed to claim the losses from such prior years even though the IRS rules would otherwise bar such returns as being untimely. IRS has appealed holding of Tax Court to 3 rd Circuit. In Notice , IRS had waived filing deadlines for late returns filed by 9/16/2003.

14 Sale of USRPI General Principles Sale is subject to U.S. income taxation as if taxpayer were engaged in U.S. trade/business during such year and as if such sale were effectively connected gain or loss (sec. 897(a)). Even if no sec. 871(d)/882(d) net basis election had been made, taxpayer may deduct amounts paid/incurred in year of sale for real estate tax, mortgage interest, insurance, maintenance, repairs and carrying charges. (CCA ) For NRA, loss is allowed (sec. 897(b).

15 Sale Income Tax Rates NRA, Foreign Trust/Estate: a) If held for longer than 12 months, apply preferential rate applicable to sec. 1231/1221 gain b) If held for 12 months or less, apply ordinary rate c) No Florida income tax Foreign Corporation: a) No preferential tax rate; ordinary rates up to 35% b) Florida corporate income tax rate of 5.5% 5%

16 Enforcement of Payment of Tax Transferee required to withhold 10% of the amount realized (sec. 1445(a)). Amount realized is sum of cash, liability assumed or that encumbers property, p and FMV of other property p received (sec (g)(5)). )) No withholding if property acquired by federal, state or local government (sec (d)(5)). Installment payments Generally, withholding tax is due at time of sale, but may be paid as purchase price is paid (sec (d)(4)) Foreclosures withholding limited to amount mortgagor receives from sale proceeds (sec (d)(3)). In case of distribution by foreign corporation, the foreign corporation withholds 35% of gain recognized (sec. 1445(e)(2); IRS Fact Sheet )). Pay over withholding tax within 20 days of transaction, using Forms 8288 and 8288-A (sec (c) 1(c).

17 Partnerships, Trusts & Estates Look-through for U.S. and non-u.s. partnerships, trusts and estates. Proceeds are FIRPTA proceeds to extent attributable to USRPI. (sec. 897(g); Notice 88-72). Partnership: Where at least 50% of value of gross assets consists of USRPI and 90% consists of USRPI plus cash/cash equivalents, then apply a full 10% withholding and look-through taxation (sec T; T). No 10% withholding required if Certificate is provided by general partner stating that partnership does not flunk the 50%/90% test (sec T(d)(1), (2). No withholding rules for trusts or estates pending IRS regulations under sec. 897(g) (sec T).

18 Exception to General Withholding Rules Withholding can be reduced or eliminated pursuant to the issuance of a withholding certificate issued by the IRS (sec.1445(b)(4). A withholding certificate will not be issued without an identification number for the transferor (sec (a). Use W-7 or SS-4 to request ID number. Basis for application of a reduced withholding certificate (Form 8288-B): a) Maximum tax liability is less than the general 10% withholding amount (including non-simultaneous like-kind ki exchanges). The tax rate for calculation of the maximum tax liability is the maximum tax rate applicable. 1) 15% for long term capital gains to individuals, partnerships, trusts 2) 35% for short term capital gains to individuals, partnerships, trusts 3) 35% for corporations (sec. 1445(f)(4), (5); (b)(4)) b) Exemption from U.S. tax due to a treaty based position (sec (b)(4)(C)). )) c) Agreement or contract transferring the liability to another (sec. 1,1445-3(b)(4)(C)). d) Sec. 121 exclusion sale of principle residence (sec (b)(5)).

19 Non-Recognition Statement No FIRPTA withholding is required with respect to a qualifying non-recognition transaction involving a USRPI where a nonrecognition statement is timely provided (sec T. -6T, Notice 89-85; 85 Notice ; sec (b)) (b)) Qualifying Non-Recognition Transaction: a) Sec. 332 Complete Liquidation b) Sec. 351 Capital Contribution c) Sec. 354 and Sec. 361 Reorganizations d) Sec. 721 Contribution to partnership e) Sec Simultaneous like kind exchange f) Sec Involuntary conversion Must exchange a USRPI for a USRPI Timely Notice No special form is required. Must send notice to IRS within 20 days of the transfer.

20 Ownership Structures Foreign Individual Foreign Corporation U.S. Real Property Annual filing requirement of Forms 1120-F and F-1120 for the Foreign Corporation. No U.S. filing requirement for the Foreign Individual. No Estate tax. No U.S. tax on the sale of the Foreign Corporation s stock. Federal and state tax on the sale/distribution of the real property. FIRPTA withholding will apply. No beneficial i capital gains rates. Ability to avoid Branch Profits Tax via complete liquidation/termination of the Branch.

21 Ownership Structures Foreign Individual U.S. Corporation U.S. Real Property Annual filing requirement of Forms 1120 and F-1120 for the U.S. Corporation No U.S. filing requirement for the Foreign Individual. Estate tax will apply to the Foreign Individual. id U.S. tax will apply on the sale of the U.S. Corporation s stock, as a USRPHC. Federal and state tax on the sale of the real property with no beneficial capital gains rate. No FIRPTA withholding. After-tax proceeds can be distributed tax-free if pursuant to a liquidating distribution.

22 Ownership Structures Foreign Individual Partner Foreign Individual Foreign Individual Partner Foreign Partnership US U.S. Partnership U.S. Real Property Annual filing requirement of Form 1065 for the U.S. Partnership. Annual filing requirement of Form 1065 for the Foreign Partnership with 882(d) election. Annual filing requirement of Form 1040-NR for the Foreign Individual. Quarterly/Annual filing requirement of Forms 8804/8805/8813 for the U.S. Partnership for sec withholding. Federal tax on the sale of the real property and partnership interests. FIRPTA withholding will not apply. Beneficial capital gains rate will apply.

23 QUESTIONS

24 Internal Revenue Service Circular 230 Disclosure Pursuant to Internal Revenue Service Circular 230, we hereby inform you that any tax advice set forth herein with respect to U.S. federal tax issues was not intended or written by Morrison, Brown, Argiz & Farra LLP to be used, and cannot be used, by you or any taxpayer, for the purpose of avoiding any penalties that may be imposed on you or any other person under the Internal Revenue Code.