Foreign nationals looking to purchase real estate in the U.S. are often unaware of how drastically the tax and real estate laws in their own countries vary from U.S. law. The most common misconception is that there are no U.S. tax ramifications in connection with the purchase of real property in the U.S. The reality is that tax planning constitutes a very important aspect of any real estate transaction involving a foreign investor.
One issue encountered by a foreign national is residency. Whether or not a foreign national is considered a U.S. tax resident will have a large impact on his/her U.S. tax liability. An individual can be in the U.S. on a non-immigrant visa and still be considered a U.S. resident for tax purposes. The “Substantial Presence Test” is a form of physical presence test and is a criterion used by the Internal Revenue Service in the United States to determine whether an individual who is not a U.S. citizen or lawful permanent resident qualifies as a “resident for tax purposes” or a “nonresident for tax purposes.” As a general rule, if a foreign national is not a tax resident under the Substantial Presence Test, such nonresident is taxed in the U.S. only on income from U.S. sources. However, if a foreign national is considered a resident for U.S. tax purposes, such taxpayer is taxed on his/her worldwide income. There are also numerous tax treaties between the U.S. and other countries (with the general objective to prevent double taxation under the law of the two countries), overriding certain rules under the U.S. Internal Revenue Code, possibly treating an apparent resident under the Code as a nonresident.
Another issue concerns the selection of the real estate holding structure and related tax planning. Foreign investors will find that their tax structure will be unique to them and the various tax planning techniques fit in some situations and not others. A proper holding structure depends on the foreign investor’s objectives, including whether the real estate is purchased as a revenue-generating or a long-term appreciating asset. Most holding structures include foreign corporations as well as both revocable and irrevocable U.S. and foreign trusts. One of the main considerations here is to minimize, and, with proper structure, effectively eliminate, the obligation to pay the U.S. estate tax (known in many countries as an inheritance tax) on the U.S.-situated assets of a deceased nonresident. The U.S. estate tax has rates of up to 40% on the fair market value of the U.S.-based real estate.
Foreign investors, enticed by the lower real estate prices in the U.S. compared to those in their home countries, continue to perceive the U.S. real estate as a safe long-term investment. Prior to making a purchase, tax planning and proper structuring should be top of mind to avoid unforeseen tax consequences and to possibly increase the profitability of the U.S. real estate investment by a foreign investor.