Foreign Investment in U.S. Real Property: Navigating Through the Income, Estate, and Gift Tax Traps

Foreign investors are investing in Florida real estate because of the great deals available. However, they need to be aware of the tax implications. The IRS considers foreign investors as nonresident aliens, and they need to be aware of federal income taxation, transfer taxation, and FIRPTA withholding requirements. This is a complex area of law, so it’s important for foreign investors to seek professional advice before making any investment decisions. Nonresident aliens are only taxed on their income from the United States, while resident aliens are taxed on their worldwide income. Green card holders are usually considered U.S. residents for tax purposes. If someone is considered a tax resident of both the U.S. and another country, the rules of the applicable tax treaty determine which country can tax them. However, tax treaties do not completely eliminate taxes on income from U.S. property. So, the U.S. government taxes foreign investors in two ways. If the investor is doing a lot of business in the U.S., their income is taxed like a regular U.S. person. But if the investor isn’t doing a lot of business, their income is taxed at a higher rate. Rental income from the U.S. is usually taxed at the higher rate, but there are some special rules that might apply. Foreign investors who own rental property in the U.S. can choose to treat their rental income as part of a U.S. business. This means they would have to pay a 35 percent tax on their income, but they can also deduct business expenses. When they sell their U.S. property, the tax rate they pay will depend on how they own the property and how long they’ve owned it. If they own the property through a corporation, they won’t get a tax break when they sell it. So, it’s better to own the property as an individual or through a different type of business. Nonresident aliens are only subject to federal estate and gift taxes on their interests in property located in the U.S. This includes real estate and stocks in U.S. companies. However, gifts of intangible U.S. property generally are not subject to gift taxation. Each state also has its own laws for taxing the estates of nonresident aliens. If a foreigner owns property in the US, they have to pay estate and gift taxes like a US citizen, but with some differences in exemptions and deductions. However, there are ways for foreign investors to own US property that can help them avoid some taxes, like setting up a trust. When a foreigner wants to buy U.S. real estate, they can use an irrevocable trust to avoid U.S. estate tax. They can transfer cash into the trust to buy the property without paying gift tax. Foreign investors may also use a trust to keep their ownership of a business entity private. If the investor sets up a trust for a family member, they won’t have to pay gift tax, and the property won’t be included in their estate when they die. This also avoids the need for probate. For foreign investors looking to invest in U.S. real estate, there are different ways to structure ownership. One option is to use a trust, where the investor gives up control of the property but may still receive some benefits. However, this can have tax implications and may not protect the assets from creditors. Another option is to use a partnership, where the investor keeps control but may have uncertain estate tax implications. Each option has its pros and cons, so it’s important to carefully consider the best choice for your situation. The IRS might say that if a foreigner invests in a partnership that owns property in the US, that investment counts as part of their estate when they die. But many experts think this is too broad of an interpretation of the law. So, foreign investors can still use this ownership structure for US property and may not have to include it in their estate when they die, as long as they follow the rules and make the right disclosures. FIRPTA is a law that makes sure foreign investors pay taxes when they sell U.S. property. When a foreigner sells U.S. property, the buyer has to withhold 10% of the purchase price and pay it to the IRS. If a U.S. business sells property, the business has to do the withholding. Rental income from U.S. property is taxed differently depending on the type of income. It’s important for lawyers to understand these rules to help their clients avoid expensive mistakes when dealing with foreign investors. 1. A trust is considered a “U.S. person” if a U.S. court can oversee it and U.S. people can make important decisions for it.
2. If someone is in the U.S. for at least 31 days in a year and the total of their days in the U.S. for that year and the two years before is at least 183, they meet the substantial presence test.
3. If a person gets a green card, they are a permanent resident unless they lose it or give it up.
4. An alien who doesn’t qualify as a resident alien can choose to be treated as one for tax purposes if they meet certain tests.
5. The U.S. has tax treaties with other countries that can affect how much tax residents or citizens of each country pay on income from the other country.
6. The U.S. and Israel have a tax treaty that affects how much tax residents or citizens of each country pay on income from the other country. When deciding where someone pays taxes, the most important factor is where their permanent home is. If that’s unclear, they look at where the person’s personal and economic ties are strongest. Deductions are taken from income before taxes are calculated, and they can include things like property taxes, repairs, and mortgage interest. Taxes can be as high as 35% for non-residents of the US.
Income that comes from things like interest, rent, and salaries is taxed for non-residents. There are different rules for short-term and long-term investments. Foreigners owning real estate in the U.S. may face difficulties with probate, which is the process of transferring ownership after death. They may not have a Florida will, and their foreign will may not be valid in Florida. This can result in the property passing to someone they didn’t want it to go to. Additionally, there may be estate taxes and if the foreigner can’t pay them, the property may have to be sold. So, there are both tax and non-tax reasons for foreigners not to own U.S. real estate in their own name. If you transfer property but still keep some rights to it, the value of those rights will be included in your estate for tax purposes. You can use a domestic self-settled trust in certain states to potentially avoid estate tax. It’s important to consult with a qualified attorney to set this up correctly. If the person setting up the trust isn’t trying to exclude it from their estate, they can set it up as an “incomplete gift” for asset protection. When it comes to foreign investment in U.S. real estate, there are specific tax rules that apply. If you have a partnership or LLC, there are special tax rules that come into play.

Source: https://www.floridabar.org/the-florida-bar-journal/foreign-investment-in-u-s-real-property-navigating-through-the-income-estate-and-gift-tax-traps/