Introduction to Taxation of Foreign Investment in U.S. Real Estate

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Who are Foreign Investors?

• A Foreign investor is a non-resident alien
  individual who is
• Not a U.S. Citizen
• Does not have Green Card
• Does not meet the Substantial Presence Test
• To meet this test, a person must be physically
  present in the United States on at least
• 31 days during the current year, and
• 183 days during the 3-year period that includes
  the current year and the 2 years immediately
  before that, considering
• All the days a person was present in the current
  year, and
• One-Third (1/3) of the days a person was present
  in the first year before the current year, and
• One-sixth (1/6) of the days a person in the
  second year before the current year.
• A Foreign investor is also foreign entity
  (Corporation, trust, partnership etc

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FDAP income and Effectively Connected Income

• Fixed or determinable annual or periodic income
  (FDAP) income also subject to tax by the US
• This includes interest, dividends, rent, etc.
• The default classification for rental income is
  FDAP income.
• FDAP income is generally subject to a flat 30
  tax (or lower treaty) rate on Gross income and
  deductions are not permitted.
• Non-Residents are taxed in the US on income
  effectively connected with a US trade or business
  (ECI) on a NET basis
• Trade or business is not defined in
  Code/regulations but is any profit motive
  activities carried on in the US on a regular,
  substantial, and continuous basis are classified
  as trade or business for these purposes.

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Nonresidents Election to treat real property
income as ECI
Nonresident are permitted to file an election
under Sec. 871(d) for individual and Sec. 882(d)
for corporations to treat income generated by US
real property as ECI
Property must be income producing for election to
be made
Election cannot made if property producing
expenses but no income
Election remains in effect all subsequent years
until revocation
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• Schedule of all the nonresidents US real
  property (and level of ownership)
• Location of each real property
• List of improvements, and
• Information on prior net elections
• Real estate held by partnership election made
  by partners (rather than at the partnership level)

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Disposition of US Real Property Interest - FIRPTA
General Rules
The sale, exchange, or transfer of United States
Real Property by foreigners may be subject to
special withholding. The amount of withholding
required is typically 15 of the sales
price. IRC 1445 - Buyer is responsible for
making sure the IRS receives the withholding Tax
within the 20 days period. Payment of
withholding tax is sent to IRS with form 8288 and
8288-A Part I is competed if the buyer is an
individual person Part II is completed if an
Entity is the buyer
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Withholding Exemption/Reduction

• Withholding is not the tax itself, and hence less
  taxable gain or loss on sale causes cash flow
  problem due to withholding.
• This exemption is exemption/reduction from
  withholding and not from tax/tax filing.
• Under some circumstances, withholding may be
  reduced or eliminated.
• Buyer intends to use the property as residence at
  least 50 of time in 2 years from closing
• Buyer must be an individual
• Sales price 300,000 or less - 0 Withholding Tax
• Sales price 300,001 - 1,000,000 - 10
  Withholding Tax
• Sales price more than 1,000,000 - 15
  Withholding Tax

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FIRPTA withholding Options

• Request a Reduction of Withholding Certificate
  Prior to Closing
• Allow Withholding to Occur and Request a Claim of
  Refund by filing the Non-Resident Income Tax
  Return

Request a Reduction of Withholding Certificate
Form 8288-B

• Treas. Regulation 1.1445-3
• Treas. Regulation 1.1445-6
• Rev. Proc. 2000-35
• IRS Publication 515
• Prepare Form 8288-B
• Prepare Attachment to Form 8288-B
• Calculation of capital gain tax
• If rental property, calculation of depreciation
  recapture and suspended passive losses, if
  applicable.

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Allow Withholding to Occur and Request a Claim of
Refund by filing the Non-Resident Income Tax
Return

• File Form 1040NR
• Must have stamped Copy A of Form 8288-A to get
  refund back from IRS
• If foreign person does not have ITIN they need to
  obtain one

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If a Non resident owns US Real Property through
100 owned LLC, can they avoid FIRPTA?

• The answer is NO
• Starting in 2017, all foreign-owned Single-Member
  LLCs that are Disregarded Entities are now
  treated as Corporations for federal reporting
  requirements (submitting information) to the IRS.
  This doesnt mean the LLC is paying tax like a
  Corporation, but rather, its simply reporting
  information like a Corporation.
• So, you may have to file Form 1120 page 1 and
  Form 5472 Failure to file penalty is 25,000
• In addition, there is New FinCen Form for
  Beneficial Ownership Disclosure starting in 2022.
  Failure to file penalty is 10,000

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Nonresident individual Transfer Taxes

• Estate Tax
• -Nonresident individuals subject to tax on all
  property located within the US
• -Shares of a domestic corporation are subject to
  estate tax but shares of foreign corporation are
  not.
• Some exceptions Bank account not used in US
  trade or business, securities generating
  portfolio interest
• Nonresident individuals receive a 60,000 estate
  tax exclusion with maximum 40 tax rate.
• Gift Tax
• Nonresident normally are subject to gift tax on
  lifetime gifts of tangible property within the US
• No specific gift tax exclusion for nonresident
  individuals, thought the 16,000 per donee annual
  exclusion is available

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OPTION 1 Individual ownership

• Advantage
• Graduated individual tax rates for rental income
  - 10-37
• Long term Capital Gains tax rate 0-20
• No Branch Tax Concern
• Disadvantage
• Gift / Estate Tax applies
• Unlimited Personal Liability
• Disclosure of ownership

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OPTION 2 Limited Liability Company

• Advantage
• Graduated individual tax rates for rental income
  - 10-37
• Long term Capital Gains tax rate 0-20
• No Branch Tax Concern
• Limited Personal Liability
• Personal Identity Protection
• Disadvantage
• Gift / Estate Tax applies

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OPTION 3 U.S. Corporation

• Advantage
• Flat Corporate tax rate of 21
• No Branch Tax Concern
• Limited Personal Liability
• Personal Identity Protection
• No gift tax IRC 2501(a)(2) US situated
  intangible property including stock of US corp is
  not subject to gift tax
• Disadvantage
• Estate Tax applies
• Capital Gain taxable as ordinary income
• Double taxation - Dividend taxable

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OPTION 4 - Foreign corporation (Not with
Inheritance Tax Treaty country)

• Advantage
• Flat Corporate tax rate of 21
• No Gift or Estate Tax
• Limited Personal Liability
• Personal Identity Protection
• Disadvantage
• Branch Profit Tax
• Capital Gain taxable as ordinary income
• Double taxation - Dividend taxable

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Why Foreign Corporation works

• The asset in the decedents gross estate is
  stock/shares in a foreign corporation. Foreign
  corporation stock/ shares are a foreign situated
  asset and are excluded from the gross estate.
• BPT can be avoided with proper tax planning. BPT
  can be avoided if the death tax treaty
  (inheritance tax treaty) exists.
• At present Death, tax treaties are in effect with
  the following countries
• Australia, Greece, Austria, Ireland, Canada,
  Italy, Denmark, Japan, Finland, Netherlands,
  France, South Africa, Germany, Switzerland,
  United Kingdom.
• Exist the USA - Form 8848 - BPT does not apply in
  the year that a foreign corporation terminates
  all US business activities.

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OPTION 5 Tiered Corporate Entities

• Advantage
• Flat Corporate tax rate of 21
• No Estate or Gift Tax
• No Branch Profit Tax
• Personal Identity Protection
• Disadvantage
• Capital Gain taxable as ordinary income
• Double taxation - Dividend taxable

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OPTION 6 Non Grantor Trust

• Advantage
• No Estate Tax
• No Branch Profit Tax
• Long term Capital Gains tax rate 0-20
• Disadvantage
• Give up ownership and control of assets

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How irrevocable trust eliminates estate tax

• No assets are includable in the decedents gross
  estate. IRC 2031.
• Settlor The Settlor is the person who creates
  the trust by placing a particular asset that s/he
  owns into the trust, which are managed by trustee
  for the benefit of beneficiary

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