It is no secret that the South Florida real estate market has been a buying opportunity for wealthy foreigners, in light of the decline in U.S. home prices and the lower value of the U.S. dollar against some foreign currencies. Investors from Canada, Latin America and Europe are buying U.S. real estate for their own use, as well as investments. According to the National Association of Realtors, foreign buyers have purchased more than $68 billion worth of U.S. residential real estate over the 12 months ending March 2013. Approximately 23% of those sales (over $15 billion) took place in the State of Florida.
Unfortunately, many foreign buyers do not consider the U.S. tax consequences related to an investment in U.S. real estate until they are ready to sell the property. When the foreigners sell the properties, they will have to pay U.S. taxes pursuant to the Foreign Investment in Real Property Tax Act (“FIRPTA”). Under FIRPTA, the foreigner is required to file a U.S. federal income tax return and pay U.S. taxes on gain from the sale of such U.S. real property as if the foreigner was a U.S. person. The tax is enforced by requiring the purchaser to withhold 10% of the gross sale proceeds of the sale at closing. Well-advised foreigners, however, consider the tax implications of the investment prior to acquisition in order to address the consequences of FIRPTA.
Most Effective Tax Planning Occurs Prior to Purchase
With proper tax planning, a foreigner planning to buy U.S. real estate can both avoid a personal U.S. tax return filing obligation and minimize the U.S. federal income taxes incurred from the operations of the property and any gain upon the ultimate disposition. Although tax planning can (and often does) occur after acquisition, the most effective tax planning occurs prior to the purchase of the real estate by acquiring the property through one or more legal entities, rather than in the foreign buyer’s individual capacity. For example, by acquiring the property through a U.S. corporation, the foreign buyer can remain anonymous to the U.S. Internal Revenue Service and minimize the amount of U.S. taxes incurred by capitalizing the corporation with a combination of debt and equity.
This structure often allows the non-U.S. lender to receive the interest payments free from U.S. federal income tax, while also allowing the corporation to deduct the interest payments and reduce its U.S. tax liability.
For a foreign investor, identifying a property and seizing the moment is typically the easiest part of the process. Choosing the right structure for the acquisition is not quite as simple – but proper planning before the purchase can alleviate risk from a legal and tax standpoint.