Foreign Investor Guide to Real Estate Investment Trusts
One of the key benefits of the United States economy is that there are not many hurdles for foreigners who want to invest in the US economy. There are several different options available to non-resident aliens who want to invest in the US economy, including investing in bonds, stocks, pooled funds, and real estate. For many foreigners, investing in US real estate feels like a sure way to make a good investment. When he nonresident alien invests in US real estate, there can be many issues involving the tax rules such as FIRPTA (Foreign Investment in Real Property Act) and Gift Tax on transfers, with reduced exclusion rates. To try to avoid – – or at least curtail — these complexities, a foreign taxpayer may consider investing in a US Real Estate Investment Trust otherwise known as a “REIT.” Let’s go through some of the basics of a REIT.
What is a REIT?
A REIT is it type of investment in which an entity holds properties that generate income and is then distributed to the investors. REITs are very popular types of investments, especially in a burgeoning real estate market, because it gives the taxpayer an opportunity to invest in real estate without having to hold real estate directly –– which can be an overwhelming proposition for taxpayers with no background in real estate.
Benefits of a REIT
There are many benefits to investing in a Real Estate Investment Trust for nonresident aliens. First of all, as a non-resident alien they are presumably not residing in the United States — or at least not residing for a sufficient number of days to become considered substantially present in the United States — and thus not taxed on their worldwide income. Generally, though, dividends are taxable, even to nonresident aliens.
No Daily Management of the Property
Owning real estate in the United States directly for someone who does not reside in the same country as that property may seem overwhelming. By investing in the REIT a person need not have to manage the day-to-day activities of the property.
Liquidity (REIT ETFs)
By investing in a REIT (especially a pooled fund REIT such as an ETF), the foreign investor has an easier opportunity to liquidate the investment if necessary. So, while owning real estate direct is not considered a liquid investment, a non-resident can simply sell their units in the REIT Fund, if liquidity is a concern.
FIRPTA is the Foreign Investment in Real Property Act. For non-resident aliens selling US-based real property, the US government wants to make sure that they are paying taxes on the gains. Therefore, the IRS requires non-residents to go through many hoops when selling USRPA. For example, there is a 15% withholding requirement on the gross price and not the sale price — and although sometimes this may be avoided by jumping through other groups and obtaining a withholding exemption certificate.
*When it comes to REITs, in general, they can escape FIRPTA as long as certain requirements or exceptions are met (such as the Domestic Controlled exception). Withholding for non-residents is 30%, but treaties may reduce the withholding
199A Qualified Business Income Deduction (20%)
Certain Qualified REIT dividends may qualify for the 20% deduction. As provided by the IRS:
Many owners of sole proprietorships, partnerships, S corporations and some trusts and estates may be eligible for a qualified business income (QBI) deduction – also called Section 199A – for tax years beginning after December 31, 2017.
The deduction allows eligible taxpayers to deduct up to 20 percent of their qualified business income (QBI), plus 20 percent of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
Income earned through a C corporation or by providing services as an employee is not eligible for the deduction. For more information on what qualifies as a trade or business, see Determining your qualified trades or businesses in Publication 535.
Disadvantages of a REIT
There are disadvantages of a REIT as well. Some foreign investors would prefer to acquire direct property and then make an election to treat FDAP as ECI. This is especially true in situations in which the taxpayers seek to earn the income on the growth of the value over time and not necessarily annual rental income. In addition, while FIRPTA can be a headache — it is also manageable in situations in which proper preparations are taken. In addition, if the taxpayer is seeking to take losses from the property to offset other income – then simply receiving dividends or other distributions from a REIT may not accomplish their goal.
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