Logo  

 

 

 

 International Business, Tax, Estate and Asset Preservation Planning

 

February 2015 

Stephen A. Malley
Malley photo

 

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.

 

Clients include:

 

*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

 

*Domestic and transnational estate and asset protection planning

Learn more about Stephen A. Malley

 

Click here


Prior Newsletters


FOREIGN BUYERS OF UNITED STATES RESIDENTIAL  

REAL ESTATE

ISSUES TO DETERMINE HOW TO HOLD TITLE

RESIDENCY RULES

I

INTRODUCTION

 

The United States continues to be seen by foreign investors as a safe-haven for real estate investment. The foreign buyers of expensive U. S. homes and estates may not intend to become U.S. Residents, subject to tax on world-wide income. The purchased home may be used for vacations, or for employees, and often for children attending U.S.schools.

 

How title is taken to such properties depends on the priorities and objectives of the Buyer.

 

The foreign buyer should first determine which of the following objectives are most important:

           

1.   Anonymity, to avoid having the buyer's name on a recorded and public document.

 

2.  Asset protection, to protect the property from Judgment creditors.

 

3.   Ensuring that the property goes to the selected beneficiaries without unnecessarily negative tax consequences. A key consideration is if beneficiaries are U.S. taxpayers.

 

4.  Avoiding U.S. estate tax, with a maximum federal tax rate exceeding 40% on the death of the beneficial owner, with very limited exemptions if the beneficiary is not a U.S. taxpayer. Estates going to Non-U.S. Citizen Spouse cannot take advantage of the current estate tax exemption of $5,240,000; rather, the exemption for estates going to non-U.S. Citizen Spouses is $60,000, although a complex Trust (QDOT) might be used. (See my Articles on International Estate Planning).

 

5.  Allowing a beneficiary to realize a "step-up" in tax basis, to market value at the death of the beneficial owner.

 

6.   Minimizing gain on sale of the property, and /or taking advantage of the favorable long term capital gains tax rates. State tax must be considered.

 

7.   Avoiding or minimizing compliance and contact with the US tax system.

 

8.   Avoiding "imputed" rental income, and/or the 30% (or treaty rate) withholding on rental income on funds transferred to the foreign owner.

 

9.  Avoiding the branch profits tax which imposes a 30% tax on U.S. source profits of foreign corporations, whether or not remitted overseas.

 

10.  The Buyer's "home country" tax and other relevant issues must be considered. For example, many common law Countries have forced heirship laws, and the property owner may want to avoid those requirements.  

 

The well informed Buyer may recognize certain objectives as of paramount importance. For example, if the intended beneficiary of the property is a U.S. Citizens or Resident, that fact alone may determine the best way to hold title.

  

 

II
A BRIEF DISCUSSION OF  

ALTERNATIVE WAYS TO HOLD TITLE:

ADVANTAGES AND DISADVANTAGES

 

A.  TITLE HELD IN BUYER'S OWN NAME

 

     ADVANTAGES:                                                          

  • Profits on sale can be taxed at low capital gains rates.
     
  • N0 expense to maintain a domestic or foreign LLC or corporation or other form of offshore structure.  
     
  • The property will receive a "stepped-up" tax basis, which, which could eliminate or at least greatly reduce taxable profit on sale by the beneficiary.
     
  • 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 beneficiary). "Home country" rules must be considered when drafting Wills and Trusts.                    

     DISADVANTAGES:

  • Loss of Privacy, because title is evidenced by a public recorded deed.
     
  • On death of the owner, the market value of the property is subject to US estate tax , with possibly only a $60,000 exemption; but it does receive the "stepped-up" tax basis.

  • If the beneficiary is a non-citizen spouse, the unlimited spousal exemption is not available. Using a "qualified domestic trust" can avoid the estate tax.
     
  • 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".  

B.  TITLE HELD BT A U.S.LIIMITED LIABILITY (LLC) OR PARTNERSHIP

 

The property can be held by a domestic LLC, or a limited or general partnership. The beneficial owner is required to obtain a U.S. tax number and the entity should file U.S. tax returns, even if zero income.   Limited or general partnerships are generally not used to hold title to U.S. property, and the following discussion therefore focuses on the LLC.

 

     ADVANTAGES OF AN LLC:

  • A level of privacy. Although the Manager of the LC must usually be disclosed in a public record, a corporate Manager can enhance privacy. Delaware, for example, may offer additional privacy arrangements.
     
  • A high level of asset protection, which may be important if the Buyer 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;
     
  • Transfer to beneficiaries can be by simple Will or Trust.
     
  • Gifting of an LLC membership interest to a foreign beneficiary may not incur gift tax, as the gift of an "intangible".

     DISADVANTAGES:    

  • The expense of maintaining the LLC.
     
  • The obligation to obtain a U.S. tax I.D. number, and possibly to file tax returns.       

C.  TITLE IN A FOREIGN CORPORATION OR OTHER FOREIGN ENTITY.

 

      ADVANTAGES:   

  • A high level of anonymity.
     
  • If a "blocker" U.S. corporation is used, stock in a US corporation is considered "sited" in the US and subject to U.S. estate tax on death of the stockholder; however, the U.S/ stock may be held by the foreign entity, which of course does not "die".
     
  • The foreign entity might be sold to a buyer, with the result that title to the property does not change, and, at least technically, the property itself is not sold. This is often difficult to arrange.
     
  • Gifting of foreign stock or LLC interests to foreign beneficiaries should not be subject to gift tax.

     DISADVANTAGES:

  • Capital gain tax rates are not available to a corporation, and proceeds are subject to withholding.
     
  • If the heir to the shares of a foreign corporation is a U.S. Taxpayer, it will become a "controlled foreign corporation" or a "personal foreign holding company", with negative tax consequences unless immediately dissolved.
     
  • On sale, an amount equal to 10% of the "realized gain" must be withheld by the Buyer for payment to the IRS; a claim for refund is allowed if the tax is less, or a certificate to permit no withholding can be obtained if there will be no gain.
     
  • If the owner or associates or employees occupy the property, the IRS can "impute" rental income, based on an assessment of reasonable rental value, thereby creating US taxable income to the corporation.
     
  • If the property is leased, profits realized by a foreign corporation could be subject to the "branch profits tax" of 30%, in addition to the corporate tax rate, and regardless of whether the profits are remitted overseas.
     
  • A foreign LLC, if it is to have a bank account, or obtain a loan (see the discussion below) will have to qualify to do business in relevant State.

D.  USE OF A U.S. TRUST TO HOLD TITLE. 

  

     ADVANTAGES:

  • The trust can provide a level of anonymity. Certain States offer higher levels of anonymity and other protective provisions.
     
  • if the property is in a properly drafted irrevocable trust, it will not be subject to estate tax.
     
  • The Trust can provide for continuing ownership, stay intact and direct its further use, and/or direct distribution to the ultimate beneficiary.
     
  • The Trust can be formed in a jurisdiction which provides maximum protection from creditors.
     
  • Use by the Trust of the principal or other family members will not give rise to imputed rental income.
     
  • Trusts are eligible for capital gains tax rates on sale of the property.
     
  • Imputed rental income from use should not be an issue.

      DISADVANTAGES:

  • U.S. irrevocable trusts are tax paying entities, subject to tax at ordinary rates, without the benefit of the graduated rates.
     
  • To keep the Trust assets out of a taxable estate, the Trust document must be carefully drafted. Control by the principal (Trustor) must be limited.

 

E.  USE OF A FOREIGN TRUST TO HOLD TITLE

 

     ADVANTAGES:  

  • Anonymity of beneficial ownership.
     
  • Avoidance of the US estate tax.
     
  • Availability of capital gains tax rates on sale (but subject to withholding as discussed above).
     
  • Simple transfer of beneficial ownership, and/or change of beneficiaries; flexibility, depending on how the Trust is drafted.
     
  • The Trust should be funded with cash from a foreign account to buy the property; otherwise transfer of funds from a U.S. account is subject to gift tax.
     
  • If the beneficiaries are not US taxpayers, continuation of the trust may serve the owner's objectives.
     
  • Asset protection, as the Trust will not generally be subject to US jurisdiction.                               
     
  • No imputed rental income.

     DISADVANTAGES:

  • If the Trust has a U.S. beneficiary, significant tax reporting and income issues arise. For example, use of the property by a U.S. beneficiary will be deemed a distribution from the Trust.
     
  • A US beneficiary is charged with his or her share of current income earned by the trust, and future distributions will be subject to the interest "throwback" rules;
     
  • If there is only a US beneficiary, it is generally advisable to require the trust to distribute the asset. However, if there are also foreign beneficiaries, the Trust can be drafted to avoid tax issues to the U.S. beneficiary.
III
FIRPTA

 

FIRPTA means The Foreign Investment in Real Property Tax Act, which requires that any US person or entity which remits real estate related profits or funds to an overseas recipient must withhold, generally, either 30 %, for taxes, and/or 10% of the "realized gain" from the sale of U.S. real estate. The foreign buyer can take advantage of tax free exchanges, but only for other "like kind" U.S. real estate. FIRPTA does not apply to gifts of U.S. "intangibles", such as foreign corporate stock.

 

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.

 

IV

FINANCING

 

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. Financing may be problematic, but not impossible. The loan must be obtained and secured by the residential property within 90 days from the date of purchase.

 

Interest payments (with limitations) and property taxes are tax deductible, but only against US source income. If the foreign buyer has no US source income, these deductions are worthless.

                               

V

US RESIDENCY

 

The foreign buyer may not intend to assume US residency, and thereby become subject to tax on world-wide income, but with an applicable Treaty, there are possible tax credits for foreign taxes paid. The application of foreign tax credits is complex and must be planned in advance.

 

Home ownership in the U.S. does not, of itself, make the 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 a person claims a closer connection and a "tax home" to another Country. This issue becomes important when, for example, the buyer might be at least temporarily a U.S. resident simply by being in the United States for a total of 183 days or more, or by the three year formula; but if such person is in the US less than 182 days during the current year, he or she can claim a "foreign tax home" and a "closer connection" to another country to avoid being treated as a U.S. resident alien and thereby avoid income tax on foreign income.

 

The rules governing US Residency are complex, but the basic rules are as follows:

 

A foreigner becomes a U.S. tax resident by having a Green Card, o, with limited exceptions, 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.

 

 

VI

GIFT TAX

 

The gift of US real estate by a foreign owner, whether to a US or foreign beneficiary,   is subject US gift tax. The exemption is very limited if the gift is to a foreign beneficiary. If gifting of the property is an objective, pre-planning is crucial.

           

VII
EXCLUSION OF TAXABLE INCOME ON SALE

 

The sale of a "principal" US residence may qualify for an exclusion of $250,000, for a single person, or $500,000 for a married couple, from taxable gain. Consideration of this exclusion is only relevant if the Buyer intends to us the property as his principal residence, in which case he or she will in effect be a US resident for income tax purposes.   

 

 

VIII

PATRIOT ACT

 

All U.S. banks and financial institutions must "know their client". A U.S. bank will require disclosure of beneficial ownership, and possibly that the foreign entity registers to do business in the State. This might be avoided if, for example, an accounting firm or other agency is hired to manage the property, pay the expenses, etc.       

           

 

SUMMARY

 

No form of title is perfect, and each has both advantages and disadvantages. The foreign buyer's objectives must be clearly determined.

 

US tax rules are constantly changing and the current law as well as anticipated future developments must be considered.

 

The foreign buyer is well advised to seek competent advice.

 

 

This article is a general overview of the complex issues discussed. This article is not a definitive discussion of the issues and subject matter and it is not intended to be legal advice.

Stephen A. Malley
A Professional Corporation
310-576-7772

 

2015 Stephen A. Malley, J.D.