South Florida has become one of the top places in the U.S. for foreign nationals investing in real estate. Whether the investment is a one million dollar condominium in South Beach or a multimillion dollar investment in commercial property in Boca Raton, the foreign individual must consider the best vehicle in which to hold the property. If the foreigner (sometimes referred in tax circles as a “non-citizen, non-resident alien” or “NRA”) plans to ultimately move to the U.S. or has family members in the U.S., additional items need to be considered and merit advance planning.
In addition to U.S. taxes, the NRA should consider the benefits of using trusts or other entities to avoid Florida probate and to devise and distribute property upon death. In some cases the individual may want to use an entity, such as a Florida land trust or LLC, for privacy concerns.
The choice of legal entity also has a material impact on the U.S. tax treatment of the ownership and operation of the real property. Two major U.S. taxing systems come into play in this setting: (i) “transfer taxes”, meaning U.S. gift, estate, and generation-skipping transfer taxes; and (ii) U.S. income tax.
The U.S. transfer taxes apply at marginal rates of up to 40%, making the Federal government a nearly equal partner with respect to taxable assets and transfers. NRAs may not realize that, merely by owning real estate in the U.S., they may become subject to U.S. transfer tax jurisdiction, even if they never stepped foot in the country. Significantly, the U.S. estate tax applies to all NRAs on “U.S. situs property”, which generally includes U.S. real estate, tangible personal property located in the U.S., stocks of entities classified as U.S. corporations for U.S. tax purposes, and certain other U.S.-based assets. NRAs have an exemption of only $60,000 from estate taxes. (Recently, the Federal estate tax exemption for U.S. citizens and U.S. domiciliaries was raised to five million, indexed for inflation beginning in 2012.) Accordingly, estate taxes can become an issue very quickly if not avoided.
Multiple strategies exist to plan for and mitigate the application of U.S. transfer taxes to U.S. real property held by an NRA. These strategies typically involve tiered ownership structures, utilizing a combination of U.S. legal entities and non-U.S. legal entities, and, potentially, trusts, through which to hold title to the U.S. real property.
The various planning structures generally pose different treatment for U.S. income tax purposes. This requires a balancing of objectives, including, for example, any relative anonymity desired by the NRA (i.e., a goal of not filing individual income tax returns in the U.S.), a goal of long-term capital gains treatment on a future sale of the real property, and, coming full circle to the U.S. transfer taxes, maximizing the degree of certainty over the transfer tax treatment. There is no single legal structure or strategy which definitively resolves all U.S. tax issues. Advance planning is crucial in order for the NRA to make the most informed decision on an organizational structure and to maximize the opportunity to realize the NRA’s estate planning and U.S. tax planning goals.