NON-RESIDENTS PURCHASING REAL PROPERTY IN THE U.S. A. The Attorneys Role in the Purchase of Real Estate The purchase of real estate in the U.S. without the proper assistance can become a complex transaction. In addition to the unfamiliar vocabulary, there are a series of complex legal and title issues that will arise. The attorney s role in the U.S. is more active than in civil law countries. Most real estate transactions will involve an attorney who will act in many instances in a similar capacity as a Notary Public in civil law jurisdictions. The attorney s job is to guide you, the client, through this process. From the start, the attorney will be able to advise you on the transaction, the potential liabilities involved, and the tax consequences that will follow. The attorney will review all the details of the transaction, ensuring that your needs are met and that documents carry out your actual intent. Having an attorney s participation is critical in protecting your investment and your financial security. The legal system in the U.S. has local state laws, which differ from state to state and federal laws which apply to all states. This article will concentrate on Florida law. Some of the responsibilities of an attorney prior to the purchase of a property will be: - Review the Contract for Purchase and Sale and advise you on the legal consequences and obligations; - Advice you on the deadlines provided in the Contract; - Explain any potential liabilities that you may be assuming; - Help you understand the effect of any title issues with property; - Discuss alternative means of financing; - Discuss how you should take title, i.e. personal, joint, or corporate; - Review and discuss insurance requirements or recommendations such as fire, liability, windstorm and other hazards. Once a contract is executed, an attorney will perform many important services, depending on the transaction, such as: - Obtain a title search, evaluate the status of titles, and require appropriate legal remedies to clear defects; - Prepare or review the Closing Statement and other closing documents, and inform you about any stipulations that may adversely affect your interests; - Interpret and counsel you about all legal documents related to the title and transaction, including deeds, mortgages, and closing statements; - Prepare a bill of sale to cover any personal property included in the sale; - Advise how title should be taken, and the effects this may have on your business or your personal estate; - Investigate zoning ordinances and other governmental use restrictions; - Discuss the income, estate, and gift tax consequences to your estate;
- Check unrecorded municipal liens, such as sewer and special assessment liens; - Advise you on what the title policy does not protect against, emphasizing insurability and marketability; and - Explain the property tax structure. i) Title Insurance. Having clear title to the property you are purchasing is essential. This means that, after the closing, the title will be free of prior indebtedness or other defects or encumbrances. When the title is free and clear, it is known as marketable title The transfer of a deed alone does not ensure that you are receiving a marketable title. An attorney can help you ensure the marketability of the title that you are receiving by conducting a title examination of the property. This involves researching the public records to disclose the previous owners or record, prior deeds, mortgages, court judgments, probate proceedings and divorces, foreclosures, tax and construction liens, and other matters that could affect title. If this research reveals any defects in the title, the seller may be asked to undertake legal proceedings to clear the defects. Even so, there are hidden defects, which may not appear even in a thorough title examination. These could include: - Lost or forged deeds; - A married signer who represents himself or herself as single; - Claims of undisclosed heirs; - Impersonation of another; - Clerical error made at the courthouse when earlier documents were recorded; - Incorrect legal description; - Instruments signed by minors; - Instruments signed by mentally incompetent persons; - Title taken as a result of an improperly probated will; or - Confusion of title resulting from similar names. Title insurance will help protect you and your property against such hidden defects, by covering the costs of defending your title in court, should the need arise. Real Estate attorney s are usually agents for the title insurance companies and earn a portion of the premium. If you are obtaining a mortgage as part of the purchase, your lender will require you obtain a policy which will insure the bank s mortgage on the property. Note that while your lender will insist on title insurance in the amount of the mortgage loan, such a policy does not protect your ownership interest. You need an owner s policy for that. The owner s title insurance policy is an agreement that the insurer will pay all losses involved in any claim covered by the policy terms. The policy provides two types of coverage: If someone contests your insured title in a legal action, the insurer will defend the title At no expense to you. If there is a defect in your title which cannot be eliminated, title insurance protects you from financial loss. Thus, you will be reimbursed up to the amount of the policy - generally, the full amount of your loss.
You pay a one-time premium for title insurance, based on the purchase price of the property, and the protection continues in effect forever -- even after you sell the property involved. An attorney, trained in the complexities of real estate law, is the best-qualified person to issue your owner s title insurance policy. In many states in the U.S., a title company will issue the insurance and will prepare the documents but will not legally represent the buyer or has an obligation to protect your interest outside of insuring title. B. Other Professionals Involved in the Transaction. Many other professionals are involved in a real estate transaction. Attorneys will need to coordinate their efforts with all of them. It is important to know what their roles are and who they represent. The Real Estate Agent or Broker Most foreign buyers will engage a real estate broker to assist them in finding the right property. Brokers specialize in either residential or commercial properties as well as in certain areas. The real estate broker is either engaged by a seller to list the property for sale ( Selling Broker ) or the buyer to find the property and assist in the negotiation of the contract terms ( Buyer s Broker ). Both real estate brokers will be paid by the seller a commission which is usually 6% of the sales price. In some commercial deals the commission could be up to 10%. An agent can help the buyer find the property that is to be purchased, and provide general information regarding the market, neighborhoods, etc. It is important to know if the broker is representing the buyer or if she is a transactional broker with no duty to keep confidential the buyer s statements to the seller. The Lender Most real estate transactions are financed through an institutional lender such as a bank or a mortgage broker. Lenders must comply with a variety of state and federal laws including the recently enacted Patriot Act which will require the bank to know in detail, the information of the borrower including the source of funds and business activity in detail. To support this information, the Lender will do a credit report and request reference letters. The lender must determine that the buyer is a good credit risk and will evaluate the property to determine its value. Mortgage Brokers are licensed to accept applications for loans and may have source of funds from private investors or may be able to obtain competitive quotes from institutional Lenders. Mortgage Brokers will usually charge a fee to assist the borrowers in obtaining the best interest rates and process the documents necessary for loan approval. The amount of financing for purchases usually ranges between 70%-80% loan to value depending on the purchase price and the type of property. On commercial deals, the loan to value is usually 60%-70%. The Appraiser When you are obtaining a loan, the lender will first request an appraisal of the property. An appraiser is a certified or licensed expert who states his or her opinion of the fair market value and the quality of the property. This determination is based on a visit to and evaluation of the property. Appraisers are assumed to be unbiased, no matter who is paying their fee. Note, however, that if you doubt the evaluation, you may hire another appraiser for a second examination. Lenders will usually lend based on the appraised value and not the contract value.
The Home Inspector and Surveyor The Inspector also examines the property, but much more thoroughly than the appraiser. The Inspector s role is to provide an objective evaluation of the structure and systems of the building involved. An inspection will usually be done if the property is not new construction but a resale. In new constructions, the Developer will inspect the unit prior to closing together with the buyer and will guarantee the condition of the property for at least one year for most defects and up to three years for other types of defects. In addition to the inspector, there may also be a surveyor of the property which will make sure that the property boundaries and legal description are correct. The survey will show any easements recorded on the property. C. Types of Properties. There are generally two types of properties: Commercial or Residential. Commercial properties may consist of vacant land, rental property or office condominiums. Commercial vacant land is usually zoned for commercial use or to develop multi-family residential property. Rental properties may be shopping centers, office space or residential rental buildings. Office Condominium buildings may rent the individual units or sell them. Most residential properties are single family homes, condominiums or townhouses. i) Commercial Properties. The contracts for commercial properties may be drawn by the brokers or by the attorneys representing the buyer or seller. Most contracts provide for a due diligence provision to allow the buyers to inspect the property and determine if it is suitable for their needs. The buyer will use this period of time, usually 45 to 60 days to order an environmental report, request a loan commitment from a Lender, review the zoning laws and building permits, order a survey and conduct a general feasibility study of the property. If the buyer decides the property is not suitable, then the initial deposit will be returned and the agreement will be cancelled. The laws regulating land use are very specific and usually require the assistance of a land use attorney to review if the intended use is permitted by the zoning ordinances. Once the zoning issue has been resolved, the buyer will have to seek the approval of the construction or remodeling in the different departments which will issue the building permits and licenses for constructions. ii) Residential Properties. Residential properties are usually condominium apartments, townhouses, or single family homes. The properties could be new construction, in which case the seller will be the Developer or a resale which are sales between individual end users. The contracts on sales of new condominiums are prepared by the Developer and usually establish a 20-30% down payment during pre-construction and will allow the Developer up to 2 year or more to finish the building. 10% of the deposit will be held in escrow with a third party and the rest will be able to be used by the Developer in construction. It is therefore important to choose a reputable Developer since the additional deposits will be at risk. Most contracts by the Developers are not subject to financing. If the Buyer is unable to obtain financing, the deposit will be at risk. Developers usually charge a 1.5% -1.75% closing charge in addition to the purchase price to pay for some of the closing expenses. Some of the units sold will be sold decorator ready meaning they will not have any flooring or finishes. This means you will have to budget the amount needed to finish the apartment.
Re-sales of units or single family homes are handled initially by the brokers. The Selling Broker will list the apartment of house and the Buying Broker will find the Buyer. The Contract used often is a form drafted by the association of realtors and lawyers. This allows for the industry to be familiar with the terms of the contracts. Lawyers should always review the contracts first before the execution of the contract. On many occasions, the clients will sign the contract first and then bring to the lawyer. By that time, the lawyer may not change any of the terms if a fully executed contract has been entered. After the contract is executed, the lawyer will assist the buyer as has been explained above. The due diligence in residential contracts consists usually of an inspection period to determine that all of the structures, appliances, roof, and other amenities are functional. This inspection period is usually no more than 10 days. Most residential contracts will have a financing contingency to allow the buyer to obtain a loan commitment from a Lender. The financing contingency period is usually 30-45 days. iii). Costs. The costs involved in the purchase of a real estate property vary depending on whether the purchase will be financed through an institutional Lender. The Lender expenses include the appraisal fee, credit report and bank fees. The total expenses could range between 1%-2.5% of the Purchase Price (PP). In addition, the banks will require some prepayment of interest and real estate taxes. If the property is a new development, the Developer will usually charge a 1.5%-1.75% of PP as a closing fee. Title charges and closing fees and governmental taxes will be approximately 1.5% -2% of PP. The total closing expenses and prepayments in a residential purchase therefore range from 3%-5% of PP. On commercial deals, the expenses will also include an environmental report and appraisal fees which will be more costly than in residential deals. Other expenses are similar. The carrying charges on a property will include the real estate taxes, insurances and any maintenance fees if the property is in a condominium or homeowners association. The real estate taxes vary from city to city but range between 1.5% and 2% of the purchase price. The real estate taxes are paid once a year in arrears. In Miami-Dade County, taxes are paid in November with a 4% discount and will become due in April for the previous year. The maintenance fee for condominiums will depend on the type of building and the size of the unit. The insurances required for a single family residence in Florida may include hazard, liability, flood and windstorm. In condominium buildings, the insurance for the common areas is included in the monthly maintenance. The costs for insurance also depend on the amount of coverage provided. D. Structures Available to Hold Real Property. The following is intended to provide you with an outline of the preferred structures available for holding U.S. real property. As a basic premise, all income derived from a U.S. trade or business is taxable regardless of the type of entity owning such trade or business. This is true whether the entity is a natural person, U.S. or offshore corporation. Since it is expected that most real estate purchases will be rented at some time of their ownership, the rental income generated as a result will be considered income derived from a U.S. trade or business and thus subject to taxation. i) Individual Ownership. If an income-generating rental property is held in a foreign individual s name, that person will have to pay taxes on the income generated from rents by filing a U.S. tax return on or before April 15 th of each year. Tax rates for individuals range from 10% to 35%. To file a return, you will have to apply for an ITIN number with the Internal Revenue Service and disclose certain personal information including the country of origin and provide your passport. If the property is not rented, you may not be able to accumulate any losses or capitalize the expenses to offset any future gain. The main advantage of holding property as an individual, other than simplicity, is a reduced tax rate of
15% on sales done after one year of ownership. One of the disadvantages is the possible estate (death) tax, imposed on U.S. property owned by non-residents at time of death. The tax ranges from 18 to 35% of the market value of the property at the time of death of the owner. There will also be a withholding of 10% of the sales price to ensure the proper payment of any taxes on the gain and lack of confidentiality (all sales are available to public). ii) Corporation or Limited Liability Company. The primary advantages of holding title to real estate in the name of a corporate entity are: a). Limited liability. In the absence of fraud, a shareholder is protected from liability for any debts of or claims against the corporation. A potential claimant would not be able to pursue the shareholder s personal assets, unless the shareholder has executed a personal guaranty. The liability of the shareholder for debts incurred by the corporation is limited to the contribution of each shareholder. Liability on ownership of property may include any damage done to other properties as a result of flooding or fire and any personal injuries on the property. b). Confidentiality. A corporation is useful in protecting a foreign individual's confidentiality and privacy with his financial affairs. Most individuals living in South American countries prefer to keep their holdings abroad confidential for security reasons. Use of a corporation as owner registers the real estate in the company's name and any correspondence that may be delivered abroad should not have the individual s name. However, the U.S. corporate tax return requires disclosure of the identity of any shareholder owning more than 25% of the corporation. c). Tax Considerations. U.S. corporations are taxed on their net income based upon the following scale:
Not over $50,000 Taxable Income Over $50,000 but not over $75,000 Over $75,000 but not over $100,000 Over $100,000 but not over $335,000 Over $335,000 but not over $10,000,000 Over $10,000,000 but not over $15,000,000 Over $15,000,000 but not over $18,333,333.33 Over $18,333,333.33 Amount of Tax 15% of taxable income $7,500.00 plus 25% of the amount over $50,000.00 $13,750.00 plus 34% of the amount over $75,000.00 $22,250 plus 39% of the amount over $100,000 $113,900 plus 34% of the amount over $335,000 $3,400,000 plus 35% of the amount over $10,000,000 $5,150,000 plus 38% of the amount over $15,000,000 $6,416,666.67 plus 35% of the amount over $18,333,333.33 Capital gains are taxable at regular corporate rates. By making an election, a U.S. corporation can depreciate its assets, capitalize expenses and accumulate losses. A certain portion of the losses can be carried over from year to year to offset gains from other U.S. sources. Furthermore, the foreign individual can hold other real property purchased in the future in the name of the U.S. Corporation. U.S. corporations however, are subject to a withholding of 30% on any dividends from the company to foreign shareholders. This causes a double tax that can only be avoided in some circumstances such as liquidation upon the sale of all of its assets. If the shares of the corporation are owned directly by individual foreign shareholders, the estate tax will also apply on the value of the shares. Therefore most structures for foreign clients use an offshore company to be the shareholder of a U.S. corporation. Some of the disadvantages of holding property in a Corporation include: higher tax rates than individual; no reduced 15% tax on sales over a year; and cost of maintaining structure. Limited Liability Companies are a hybrid between a corporation and a partnership. They provide limited liability but the tax is paid by the individual tax payers not the corporation. Additionally, if the property is held for more than a year, the capital gains tax will be 15% instead of the corporate rate. Therefore, you can have the advantage of limited liability and also avoid the double taxation of regular corporations on dividends. The LLC s disadvantages include: exposure to estate (death) tax; individual owner to file income tax returns; and lack of confidentiality.
iii). Offshore or Foreign Corporations (FC). The advantages of owning real property in the name of a foreign low tax jurisdiction (FC) such as a British Virgin Island (BVI) corporation are similar to those listed above for a U.S. corporation. Shares of a FC, however, are not subject to estate tax in the United States. As a result, the foreign individual s U.S. based assets held in the name of a FC are not subject to U.S. estate tax. The benefits of a BVI are: 1. No taxes on earnings outside of the British Virgin Islands. (U.S taxes will be paid on sales.) 2. No minimum capital requirements. 3. Only one shareholder and one director required. 4. No public record is kept on the identity of shareholders. 5. There is no requirement for an annual accounting or filing of tax returns with local governmental authorities. (U.S tax returns will be required if the corporation engages in business in the United States. Rental of the property is deemed to be engaged in a U.S. business.) In the event of the sale of U.S. real property owned by a FC, the FC should be liquidated in order to avoid the branch profits tax. This tax is imposed when a foreign corporation earns income and does not liquidate, reinvest or distribute the proceeds. Thus, it is beneficial to utilize one or more Florida corporations which in turn may be owned by a foreign corporation if holding more than one property. It is important to note that at the time of sale of the real property, the BVI, as well as foreign individuals will be subject to a withholding of 10% of the sales price in order to guarantee the payment of any tax due. CONCLUSION The successful purchase of real property in the U.S. requires the assistance of many professionals. Choosing the right assistance will greatly enhance your chances of a smooth purchase and profitable investment. The attorney will be able to assist you in the coordination and recommendation of the different professionals, review of title, drafting of contract and choosing the right structure to purchase. Most of the real estate lawyers will charge a flat fee which will be reduced, and not be equivalent to the hours worked on the matter as a result of the fee they will earn as title agents.