|Stephen A. Malley|
Stephen A. Malley has for over 40 years specialized in the areas of international business, tax and finance, transnational estate, tax, and asset protection planning, and pre-immigration and expatriation planning. Mr. Malley's practice includes domestic and foreign licensing of intellectual property, and the formation of captive liability insurance companies.
*U.S. companies with or developing foreign operations
*U.S. citizens with foreign assets or conducting business and investing overseas
*Foreign individuals with U.S. assets and/or U.S. business.
*Transnational Estate and asset preservation planning.
Learn more about Stephen A. Malley
FOREIGN BUYERS OF U.S. RESIDENTIAL REAL ESTATE:
TITLE ISSUES AND CONSIDERATIONS
Many foreigners (e.g.non-resident aliens) purchase expensive US homes and estates. Some may become U.S. residents, subject to tax on world-wide income, and some have no such intention; their children or employees may use the property, or the buyers may use it for less than the requisite time to become U.S. taxpayers.
Regardless of intended use, foreign buyers are well advised to consider the issues relating to the various forms of holding title to real estate.
The foreign buyer should determine which of the following objectives are most important:
- Anonymity, to avoid having the buyer's name on a recorded public document.
- Ensuring that the property goes to the selected beneficiaries without unnecessarily negative tax or other consequences.
- Protecting U.S. (or foreign) beneficiaries from U.S. estate tax or creditor claims.
- Avoiding U.S. estate taxes on the death of the property's beneficial owner(s).
- Obtaining a tax basis "step-up to market value" at the death of the beneficial owner.
- Minimizing income tax on sale of the property, and /or taking advantage of the long term capital gains tax rates.
- Avoiding compliance reporting and contact with the US tax system; a foreign real property owner may be required to file a real property investment information form.
- Avoiding "imputed" rental income, and/or the 30% or treaty rate withholding on rental income on funds transferred to the foreign owner.
- Avoiding the branch profits tax which imposes a 30% tax of the U.S. profits of foreign corporations (foreign owned), whether or not remitted overseas.
- Finally, the Buyer's "home country" tax and other relevant issues must be considered.
FORMS OF TITLE
ADVANTAGES AND DISADVANTAGES
1. TITLE HELD IN BUYER'S OWN NAME
The advantages to holding title in the Buyer's own name include:
- Profits on sale can be taxed at low capital gains rates;
- Minimal cost, with no expense to maintain a domestic or foreign entity;
- On death of the property owner, the property will receive a "stepped-up" tax basis to market value, which could eliminate or at least greatly reduce taxable profit on sale;
- The property can be easily transferred on death to a beneficiary, by a simple will or trust. (but see below with reference to non-US citizen beneficiaries);
- The foreign buyer can take advantage of statutory tax free exchanges (for domestic property only).
The disadvantages to holding title in the foreigner's own name include:
- Loss of Privacy, as title is evidenced by a recorded deed.
- At death of the owner, the market value of the property may be subject to US estate tax;
- If a beneficiary is not a US Citizen, regardless of US residency, the estate will receive minimal estate tax exclusion (currently $134,000). However, a Qualified Domestic Trust" can avoid the estate tax but this subject is beyond the scope of this article. Note that for estate tax purposes, any mortgage on the property will not be allowed as a deduction from market value unless it is "non-recourse".
2. U.S. LIMITED LIABILITY (LLC) OR PARTNERSHIP
The property can be held by a domestic or foreign LLC, or a limited or a general partnership. In any of these, a foreign member or partner is required to obtain a U.S. tax number and to file U.S. tax returns to report U.S. source income. Residential property may not produce income, but a tax number is nevertheless required. As of just recently, the IRS will not issue an ITIN to a foreigner unless the applications includes original documentation such as a passport or birth certificate, or a copy certified by the issuing agency.
Limited or general partnerships are generally not used to hold title to U.S. residential property, and the following discussion therefore focuses on the use of a limited liability company (LLC). The advantages of using a domestic or foreign LLC include:
- A level of privacy. Although the Manager of the LLC must usually be disclosed in a public record (not in all States), the actual beneficial ownership can often remain confidential, if not secret;
- Asset protection, (when the documents are property drafted) which may be important if the Buyer or beneficiary has other U.S. business activities;
- Availability of long term capital gains tax treatment on sale;
- At the beneficial owner's death, the beneficiary receives a step-up in tax basis to market value;
- The LLC form provides flexibility in estate and gift planning, with possible reduced values on gifts of Membership interests.
- Limited liability usually afforded by LLC legislation.
3. CORPORATE OWNERSHIP
(a) Holding title through a foreign or "offshore" corporation.
- Shares of stock in an offshore corporation are not considered "sited" in the U.S., and should not therefore be included in a non-resident alien's U.S. estate.
- The corporate stock of an offshore corporation might be sold to a buyer, and title to the property does not change; and, at least technically, the property itself is not sold and therefore there is arguably no tax due. However, this form of sale can rarely be accomplished and then only at a discount, as the buyer, whether domestic or foreign, does not get the benefit of a new tax basis equal to the purchase price.
- A possible shield to personal liability.
Disadvantages of the foreign corporate structure include:
- Capital gain tax rates are not available to a corporation;
- If the owner, or other US or foreign employees, occupy the property, the IRS may "impute" rental income, based on an assessment of reasonable rental value;
- Profits realized by a foreign corporation, for example from rental income or imputed rental income, may be subject to the "branch profits tax" at 30%, in addition to the corporate tax rate, and regardless of whether the profits are remitted overseas.
- If a U.S. taxpayer owns or controls the offshore corporation, it is a "controlled foreign corporation" with numerous reporting and tax issues. A U.S. beneficiary will usually want to dissolve the foreign corporation.
(b) U.S. corporation to hold title
- Corporations do not "die", and stock in a US corporation is (with exceptions) deemed "sited" in the US and may therefore be subject to U.S. estate and gift tax;
- Loss of anonymity, as most States require that the names of officers and directors be filed in a public document;
- Foreign ownership of a U.S. corporation may have to report to the Treasury depending on activity;
- Possible limit to personal liability.
4. FOREIGN TRUST TO HOLD TITLE
Holding title through a Foreign Trust may offer several advantages, especially if there are no actual or potential U.S. beneficiaries. Advantages may include:
- Asset protection;
- No U.S. reporting or tax returns if no U.S. source of income;
- No exposure to U.S. estate or (most likely) gift tax
- The Trust can provide for continuing use by subsequent beneficiaries.
- "Imputed rental income" should not apply if the residence is used by family members or employees;
- Foreign Trusts are eligible for capital gains tax rates, but the current tax exclusion on sale of a principal residence will not apply.
Use of a Foreign Trust may not be of interest if the beneficial owner or Settlor expects to become a U.S. resident or Citizen; the Trust would become a "grantor trust" to be reported annually and the property will become subject to U.S. estate and gift tax.
Disadvantages of the use of a foreign trust to hold title will arise if the beneficiary is a U.S. taxpayer or if the property realizes income. Sale proceeds from a U.S. buyer will be subject to withholding (usually 10% of "realized gain" which is not related to profit.
FIRPTA, or The Foreign Investment in Real Property Tax Act, requires that any US person or entity which remits funds overseas from the sale of or rental from U.S. real estate, or who sends stock is a U.S, "real property holding company, must withhold (usually) 10% of the "realized gain" from the sale of U.S. real estate, which is not related to the profit. Any refund due must be claimed with a tax filing.
The foreign seller of real estate buyer can obtain a Certificate from the IRS to reduce the amount of tax to be withheld, to be based on the seller's maximum U.S. tax liability, but this requires time and the maintenance of very accurate records.
The foreign buyer who wishes to obtain U.S. financing for the purchase of property must recognize that the form of title will be significant to the Lender, which must, at the very least, determine if the borrower has the income and assets to justify the loan, and these days that is often problematic regardless of wealth.
Foreign buyers often have no US source income, and a US lender, certainly in today's market, will generally not be able or willing to issue a loan based on foreign assets, and a lender may require additional security. If financing is required or desired, the prospective buyer should determine the availability of the loan before committing to a particular form of title.
Allowable interest payments and property taxes are tax deductible but only against US source income. If the foreign buyer has no US Source income, these deductions may be worthless to him or her.
The mortgage loan must be obtained and secured by the residential property within 90 days from the date of purchase.
Home ownership in the U.S. does not, of itself, make a residential property owner a U.S. resident for income tax purposes. However, it is the first "tie breaker" rule in income tax treaties, to be applied when residency is in question. This issue might become important when, for example, a foreigner is in the US less than 182 days during the current year, and claims a "foreign tax home" and a "closer connection" to another country, to avoid being treated as a U.S. resident alien, but U.S. home ownership might make that a difficult argument to make to the IRS. (Facts are of course most important).
The rules governing US residency are complex and beyond the scope of this article. The basic rules of residency are as follows.
A foreigner becomes a U.S. tax resident by having a Green Card, or by simply by remaining in the US. 183 days or more in any single calendar year, or by being in the US for a total of 183 days as determined over a three-year period by the following formula:
The multiplier is:
Current year 1 X number of days in the U.S.
1st preceding year 1/3X
2nd preceding year 1/6X
A foreign owner who becomes a US resident should be aware that, although he or she is subject to income tax on world wide income, (with applicable credits), the U.S. estate tax is based on "domicile" and not on residency. "Domicile" can essentially be defined as the country or place where the taxpayer intends to permanently reside at some future time; it is therefore subjective and there is substantial case law on the subject.
In any case, it is possible that, with good pre-planning, the resident alien can establish a Non-U.S. domicile for estate tax purposes, to thereby exclude foreign- based assets from
his or her U.S. estate.
All U.S. banks and financial institutions must "know their client". A U.S. bank will often require that the foreign entity, including a foreign trust, register to do business in the particular State. The foreign owner or entity might consider using an accounting firm or other agency to manage the property and pay the expenses.
No form of title is perfect, and each form has both advantages and disadvantages. The foreign buyer's objectives must be clearly determined as a prerequisite to selecting how to hold title to US residential real estate.
US tax rules are constantly changing and the current law as well as anticipated future developments must be considered. Congress has made clear its intention to focus on foreign transactions.
The foreign buyer is well advised to seek competent advice.
This article is a general overview of issues to be considered relating to holding title, and the advantages and disadvantages of each form. This article is not a definitive discussion of the subject, and it is not intended to be legal advice.
Stephen A. Malley
A Professional Corporation
©2012 Stephen A. Malley, J.D.