By Pieter A. Weyts1 October 15, 2014 How to Buy U.S. Real Estate as a Non-U.S. Person Navigating the tax considerations of buying U.S. real estate It happens every day in Miami and throughout the United States: a non-u.s. person ready to close on their first piece of U.S. real estate. The buyer is excited and already thinking of how to redecorate the place. And then the real estate broker asks: Who will be the buyer of the property? You, or one of your companies? And confusion sets in. The buyer start asking around for advice. Friends bought their property in their own name. Someone else suggests to buy through a U.S. company. Another friend says the property should be owned by an offshore company. An attorney the buyer met at the Admirals Clubs in Miami mentions something about a trust 1 Pieter A. Weyts is a partner at the Private Advising Group, a Miami-based law firm focused on advising international clients. Pieter can be reached at pieter@private-advising.com - 305-445-2646
The good news is that non-u.s. buyers of U.S. real estate are not alone. Non-U.S. persons are buying U.S. real estate in unprecedented numbers. For instance the National Association of Realtors said 23 percent of Florida s sales in the 12-month period ending in March 2014 were to non-u.s. buyers. 2 And the question of how to title that real estate is an issue that each non-u.s. buyer should consider carefully. How to title property involves a tradeoff between privacy, complexity, tax efficiency and costs. The purpose of this article is to consider the pros and cons of the most common alternatives as to how to title U.S. real estate by non-u.s. persons. This remains the easiest alternative. No structuring is required. The buyer can just sign the purchase contract and close. There are some significant drawbacks, however, to keep in mind. Death Tax The most important concern is the U.S. estate tax or death tax. If a non-u.s. person were to decease when holding U.S. real estate, an estate tax of up to 55% on the value of the property could apply (with an exemption on the first $60,000 of taxable assets for non-u.s. persons). Yes- up to 55%. And in case there is a mortgage on the property, the mortgage amount would not be deducted from the value. The estate tax liability could therefore be significantly higher than the equity that an owner has in the property. Many clients who are buying property valued at under $1 million often choose to purchase a life insurance rather than doing more structuring or setting up new entities. The life insurance policy has to be in an amount that is sufficiently large to hedge against the risk and cover the potential death tax liability. When a non-u.s. person holds U.S. real estate in personal name, the rental income from the property will be taxable in the U.S. If the property is not related to a U.S. trade or business, a withholding tax of 30% on the gross income of the property will apply (which the tenant is required to withhold from the withhold from the rental payment). Alternatively, the non-u.s. owner could make a net basis election and choose to file a tax return in the U.S. In such case, expenses could be deducted from the rental income and income tax would be payable on the net income at the applicable marginal rates (between 10% and 39.6%). In general, a rental property will generate sufficient expenses and depreciation so that the net taxable income would be relatively low or even negative. 2 http://www.miamiherald.com/news/business/article1974580.html#storylink=cpy 2
Capital Gains When the property is sold after more than one year, a lower preferential tax rate between 0% and 20% would apply to any capital gain. The buyer of the property would be required, however, to withhold a 10% FIRPTA withholding tax on the gross proceeds of the sale. The FIRPTA withholding tax is another major reason not to buy U.S. real estate in personal name. The main benefit of buying property with a non-u.s. corporation is that, when structured correctly, the non-u.s. owner s interest in the corporation should not be subject to U.S. estate taxes when the owner deceases. The non-u.s. owner would also not be required to file an individual tax return in the U.S.; only the non-u.s. corporation may have to file a U.S. tax return. There are some major disadvantages, however, such as double taxation, the absence of preferential tax rates on capital gains, and the U.S. branch tax. In addition, a non-u.s. corporation would also be subject to the 10% FIRPTA withholding tax described above. Any rental income would be subject to a withholding tax of 30% on the gross income of the property, or alternatively, the non-u.s. corporation could file a corporate tax return in the U.S. with applicable federal tax rates. On $50,000 of taxable income, the tax rate would effectively be 15%, on $75.000 it would be 18%, on $100,000 it would be 22% and on $335,000 or more it would be 34%. The non-u.s. corporation would also be subject to applicable state corporate tax, which is 5.5% in Florida and deductible for U.S. federal income tax purposes. When a non-u.s. corporation is subject to U.S. corporate tax, the income from the property would effectively be subject to a double taxation": corporate tax at the level of the corporation as well as the applicable withholding tax when the corporation distributes dividends to its shareholders. The withholding tax on dividends is 30%, unless a lower withholding tax applies based on the tax treaty (if any) between the U.S. and the country of incorporation. The easiest way to avoid this double taxation would be to use a partnership, as discussed below. Capital Gains Upon resale of the property, any capital gains would not be taxed at the preferential tax rates for long-term capital gains but would be subject to the same corporate tax rates as the rental income. U.S. Branch Tax In addition to the applicable corporate tax, a non-u.s. corporation would also be subject to U.S. branch tax of up to 30%. The branch tax is payable on the so-called dividend equivalent amount and was designed to mirror the tax that would apply as if the corporation was a U.S. corporation distributing a dividend to its non-u.s. shareholders. If the non-u.s. corporation does not earn any income until such time that it resells the property, the non-u.s. corporation could be liquidated without being subject to any U.S. branch tax on the capital gain. One way to avoid the U.S. branch tax on income of the non-u.s. corporation would be to incorporate a U.S. subsidiary of the non-u.s. corporation. 3
When buying a property for investment purposes with the goal to earn rental income, the U.S. branch tax could be avoided by incorporating a U.S. subsidiary of the non-u.s. corporation. Also, the non- U.S. person s interest in the non-u.s. corporation should not be subject to U.S. estate tax when the non-u.s. person passes away. In addition, a sale of the property by the U.S. subsidiary would not be subject to the 10% FIRPTA withholding tax described above. The U.S. subsidiary could be a U.S. corporation or a limited liability company (LLC) that elects to be treated as a corporation for tax purposes. Assuming the U.S. subsidiary withholds the required amounts on dividends paid to the non- U.S. corporation, neither the non-u.s. corporation nor the non-u.s. person individually would be required to file a U.S. tax return. Capital Gains The rental income of the U.S. subsidiary would be subject to federal and state corporate tax, as described above. When the U.S. subsidiary declares a dividend it would also be subject to the withholding tax on dividends. Such withholding tax could be avoided through proper structuring, however, if the U.S. subsidiary retains its earnings until all real estate is sold and the subsidiary is then liquidated. Similar as in the case of real estate held by a non-u.s. corporation, upon resale of the property, any capital gain would be subject to the same corporate tax rates as rental income and would not benefit from preferential long-term capital gain rates. The best way to avoid the double taxation of profits of a corporation (both at the level of the corporation and the applicable withholding tax on dividends) would be to use a partnership or a limited liability company (LLC). In the U.S., an LLC with at least two shareholders (so called members ) would be treated as a partnership for tax purposes. A partnership is a flow-through entity and its profits and losses flow directly to its partners, thereby avoiding taxation at the level of the partnership or LLC. In Florida, because of the absence of a state income tax for individuals, the profit would not be subject to the 5.5% Florida tax that would apply in the case of a corporation. Any rental expenses and depreciation of the property could significantly reduce the partnership s net profit from rental activities. Any net profit that is allocated to a non-us partner would be subject to a withholding tax of 35%. Depending upon the applicable tax treaty between the U.S. and the non-u.s. partner s home country, the partner could be exempt from taxation in their home country on their profit allocation. Alternatively, if the non-u.s. partner would file a U.S. tax return, any rental income would be taxed as ordinary income, but the partner would get credit for the tax that was already withheld by the partnership or LLC. This could present an obstacle for certain non-u.s. persons, however, who prefer not to file individual income tax returns in the U.S. 4
Capital Gains Upon resale of the property, any capital gain allocated to non- U.S. partners that are individuals would benefit from the preferential long-term capital gain rate. If the U.S. real estate would be held by a non-u.s. partnership, any sale would, however, be subject to the 10% FIRPTA withholding tax. The main drawback of using a U.S. partnership or LLC to buy U.S. real estate is that the non-u.s. partner s interest in the partnership or LLC would be subject to U.S. estate taxes in case the non-u.s. partner would decease. Even when using a non-u.s. partnership, there is legal uncertainty as to whether the non-u.s. partner s interest would be subject to U.S. estate taxes. When a buyer chooses a partnership to hold their U.S. real estate, we generally recommend purchasing a life insurance policy in order to cover the exposure to U.S. estate taxes. Using a U.S. LLC that is owned by a non-u.s. partnership would generally result in the same tax treatment as using a (U.S. or non-u.s.) partnership or LLC where the profits would flow through to the partners without any double taxation or any applicable branch tax. The main tax benefit versus the use of a non-u.s. partnership is that there would not be any FIRPTA withholding tax when the LLC sells the property. Using an LLC to own U.S. real estate may also be more acceptable to lenders and have other non-tax-related commercial advantages. The same drawback remains, however, as in the case of using a partnership: the IRS could take the position that the non-u.s. partner s interest in the non-u.s. partnership is subject to U.S. estate tax in case the non-u.s. partner would decease. The optimal solution is to structure the ownership of the U.S. LLC using a non-u.s. trust. A non-u.s. trust has the added benefit of anonymity of the ultimate beneficial owner. Unfortunately, this structure is much more expensive to implement and may be cost-prohibitive depending on the size of the investment. Generally, we would recommend this solution only for real estate investments in excess of $2 million. * * * What would ultimately be the most efficient way in any particular situation will depend on the size of the investment and the laws of the buyer s home country, including the applicable tax treaty between the home country and the U.S. The good news is that there are really only a handful of alternative ways to hold an investment in U.S. real estate, each with their advantages and disadvantages. Disclaimer: The information in this article is intended as a general overview of certain alternatives for acquiring U.S. real estate, and it should NOT be used as a substitute for legal advice from a qualified attorney or a real estate professional experienced with non-u.s. buyers. Before making any purchase of real estate you should speak with an attorney and/or a real estate professional who can review your own personal situation and advise you accordingly. 5