Foreign Investors in Real Estate and US Tax
When it comes to foreigners who want to invest in the United States, one of the main access points for entry is to invest in real estate. In general, the value of real estate goes up over time and there are many uses for real estate that can generate income. In addition, unlike many other countries across the globe, there are no citizenship or residency requirements for non-US persons who want to invest in US real estate. The problem becomes when the foreigner wants to begin collecting rent or flip the property — and the different US tax laws that may apply. It is important for foreigners who are seeking to invest in US real estate to have a good understanding of the different tax considerations. Let’s discuss the basics of four important tax considerations for foreign owners of US real estate.
Rental Income and FDAP Taxation
FDAP refers to Fixed, Determinable, Annual, and Periodic income. It is a term given to US-sourced income generated by non-resident aliens. In general, there is a 30% withholding by the withholding agent on income generated in the United States — that is owned by a foreign non-US person (treaty rights may reduce or eliminate withholding) –– and is not by default considered ECI (Effectively Connected Income). Tax implications of FDAP are harsh for rental income because it would not allow for any deductions. Therefore, the foreign owner of the property can make an election for the income to be treated as ECI.
FIRPTA on Sale of Real Estate
FIRPTA refers to the Foreign Investment in Real Property Tax Act. In general, capital gains generated in the United States on assets owned by foreign persons are not taxable. There are various exceptions, exclusions, and limitations — but this is the general rule. This general rule though does not apply to US real estate and in order to make sure that foreigners pay property taxes — FIRPTA requires the withholding of 15% of the sale price – – not the gain at the time of the sale transaction. This is to ensure that foreigners pay property tax on capital gains generated from the sale of US property. In order to minimize or eliminate this requirement, foreigners can seek a withholding exemption by filing Form 8288-B.
Gift Tax on Real Estate Gifts
When a US person gifts assets, there is a lifetime exclusion, which allows for many gifts to be passed to family members and others without any immediate tax implication. While it requires the filing of Form 709 — there is not usually any tax due. This does not hold true for transfers of property by foreign persons when the property is US property — and can result in an immediate tax implication without any exclusion amount available. Proper tax planning should take place before any execution.
Estate Tax on Real Estate Transfers
When a US person passes away, their estate is entitled to an $11,000,000+ exception/exclusion so that most of the time there will be no estate tax due by the decedent’s estate. Conversely, when it is a foreign person with US property, that $11 million exclusion is reduced all the way down to $60,000. Therefore, when acquiring US real estate for the long term, non-US persons must plan properly in order to try to minimize, if not avoid, US tax.
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