Foreign Investment in U.S. Real Estate
Although it is relatively easy for foreign investors to purchase real estate in the U.S., tax structuring is highly complex and depends upon a number of factors, including the type of real estate being purchased, the anticipated holding period, the purpose for which the property is being held, and the existence or non-existence of tax treaties between the U.S. and the investor’s home jurisdiction. One of the very first decisions made by an overseas investor that can tip the scale towards either profit or loss is the choice of entity utilized to make the purchase.
Most states will allow a non-resident alien to own real estate directly as an individual. However, there are drawbacks, namely its ineffectiveness for tax planning and a lack of anonymity. Purchasing U.S. real estate as an individual also subjects the buyer to U.S. estate tax and may create gift tax issues.
Investment through a domestic corporation
Purchasing real estate through a corporation continues to be popular with foreign investors. Investment through a U.S. corporation provides a foreign investor with a liability shield and is conducive to tax planning since it provides tax benefits, particularly in high tax jurisdictions such as California.
The Tax Cut and Jobs Act sets a flat U.S. corporate tax rate of 21% as of January 1, 2018. The effective tax rate for corporate income distributed to a non-U.S. person is now 44.7 percent – a rate that may be significantly reduced if there is a relevant tax treaty (which may also waive the 30 percent tax withholding requirement). The minimum corporate income tax rate is 10%.
Investment through a foreign corporation or trust
Foreign persons also enjoy investing in U.S. real estate through foreign corporations and trusts, and are subject to U.S. income tax on income “effectively connected” to a U.S. trade or business. As of January 1, 2018, non-U.S. corporations are subject to a tax of 21% on U.S. business income and gains (including real property income and gains).
The benefits of investment through a foreign corporation or trust also include estate tax protection and anonymity of shareholders. Note, however, that there are withholding requirements, and special planning must be made to prevent the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) from being triggered and to avoid the 30% branch profits tax – all of which may also be lowered or waived by a relevant treaty provision.
Investment through a partnership or LLC
Foreign partners are required to file a U.S. income tax return and pay tax on income that is “effectively connected” with the trade or business of the partnership. Gains from the sale of real estate, however, may be taxed as effectively connected income (ECI) regardless of whether or not a partner is engaged in a U.S. trade or business. Partnerships with foreign partners also need to comply with FIRPTA filing requirements and tax withholding.
If a non-resident alien wishes to own property in their own name but still seeks liability protection, they can take title in the name of a limited liability company (LLC). In that case, the income and estate tax rules will be the same as for individual ownership.
Note that under the new tax law, non-U.S. individuals with direct or pass-through U.S. trade or business income may also take advantage of the new 199A 20% business deduction.
Strategic tax planning for maximum investment returns
Navigating U.S. tax laws, IRS reporting requirements and international tax treaties is a meticulous task. It is always important for foreign investors to consult with a knowledgeable tax attorney before acquiring property within the United States. The highly experienced Moskowitz, LLP team can help you navigate income, gift and estate tax issues, manage any tax disputes and litigation, and successfully plan your U.S. investments. We assist hundreds of foreign investors with their U.S. real estate purchases, particularly those in the San Francisco Bay Area. Call our offices at (888) 829-3325 or (415) 394-7200.