Mistake No. 1
â€œI do not need to worry about estate taxes; I am in good healthâ€
Even if you are young and healthy, itâ€™s never too early to start planning for what will happen to your estate when you are gone and how much tax your loved ones will have to pay. The United States imposes an state tax at a rate up to 40 percent on the portion of a foreign individualâ€™s gross state (assets controlled by taxpayer ) situated in the United States that exceeds $60,000. The gross state includes real estate as well as other assets such as stocks of U.S. corporations located in the United States. Accordingly, a foreignerâ€™s state is generally subject to U.S. state taxation if the foreigner dies owning U.S. real estate directly ( and in certain cases, indirectly through an entity). If the foreign decedent owns the U.S. real estate jointly with another individual, the full value of the U.S. real estate is taxed except the extent the surviving joint tenant can prove he or she contributed to the original purchase of the U.S. real estate.
A tax attorney and certified public accountant can work with a foreign buyer to ensure that he or she is fully aware of the tax consequences of buying U.S. property.Â
Mistake No. 2
Believing that use of a foreign corporation will offer protection from U.S. estate tax.
This may be true if it is done correctly. In general, purchasing U.S. real property through a foreign corporation can shield a a foreigner from the U.S. estate tax. The shares of a foreign corporation are considered non-U.S. situs property, wich means the shares of the foreign corporation are considered as being situated outside the United States. As such, they are not subject to U.S. estate tax upon the foreignerâ€™s death. However, for such corporate ownership to be respected for tax purposes, it is important that the foreign owner of the foreign corporation enter into a lease agreement with the foreign corporation any time that foreign owner uses the underlying real estate for personal purposes. Adequate rent for for such personal use should be paid to the foreign corporation, which may have U.S. income tax consequences as well as require the filling of both a federal and a Florida corporate income tax return.
Otherwise, the Internal Revenue Service could assert that the foreign corporation lacks substance and that the underlying U.S. real property is owned directly by the foreigner, thereby subjecting that U.S. property to estate taxation.Â
Mistake No. 3
Deciding to use the same structure used by a friend.
Buying U.S. real estate through a foreign corporation can potentially insulate a foreigner from U.S. estate tax if the sale is structured properly.
However, this structure will result in significantly higher income tax when the foreigner sells the property. A foreign corporationâ€™s capital gains from the sale of real estate is subject to combined U.S. federal and Florida corporate income tax rates totaling up to 38 percent. There is also the potential of an additional 30 percent U.S. branch profits tax, which is an extra income tax that the United States imposes on a foreign corporationâ€™s earnings.
On the other hand, capital gains earned by an individual or pass through entity, such as a limited liability company, are subject to capital gains tax of up to 20 percent in 2013. Accordingly, if a foreigner intends to invest in U.S. real estate and sell it for profit, a foreign corporation is clearly not a good ownership vehicle.Â
Mistake No. 4
Transferring oneâ€™s U.S. real estate to someone else.
A foreignerâ€™s gift, sale or other transfer of U.s. real estate is generally subject to U.S. income tax under the Foreign Investment in Real Property Tax Act ( FIRPTA). The federal government collects this income tax ( or at least a portion of it ) by requiring the recipient ( e.g; the buyer) of the U.S. real estate to withhold 10 percent of its gross proceeds or fair market value. In a situation where an entity technically has to pay 10 percent to the IRS.
The legal requirement to withhold 10 percent under FIRPTA exists regardless of whether there is any gain or ultimate income tax liability due as a result of the transfers. Further, in 2013 the federal government imposed a gift tax on the transfer of U.S. real estate to the extent that the gift exceeds $14,000 ( or $143,000 if the gift is made to a spouse). For example, if a foreigner owns U.S. real property and has the title conveyed to himÂ or herself and others as joint tenants, with rights of survivorship, there is an immediate ( and potentially taxable ) gift to the real property.
Finally, Florida imposes a documentary stamp tax on the sale of real estate in Florida and certain other transfers to the extent that the real estate is mortgaged. A foreign should carefully analyze the associated tax costs before transferring title to real estate in Florida. Â
Mistake No. 5
Thinking, â€œI am fine as long as I donâ€™t stay in the United States for more than six month in a yearâ€
Many foreigners believe that they can be physically present in the United States up to six months each year without becoming a U.S. tax resident for income tax purposes. However, this is technically incorrect. A foreigner is deemed to be a U.S resident for income tax purposes if the average number of days spent in the United States over a three-year period equals or exceeds 183 per year.
Under this â€œsubstantial presenceâ€ test, a foreigner will generally become a tax resident if he or she is physically present in the United States for more than 120 days per year. There are exceptions to this ruleÂ if the foreigner is physically present fewer than 183 days in a tax year and has a closer connection to another country ( i.e; has a residence in a foreign country , has business ties in the foreign country, votes in the foreign country, etc. ), or is a resident of a country that has an income tax treaty with the United States.
In closing, a real estate broker/agent is Â in a unique position to help foreign customers mitigate some of the adverse U.S. and Florida tax consequences associated with owning U.S. property. Keep in mind that there are complex tax issues involved when foreigners purchase, own and dispose of U.S. real estate and that no two foreign buyers are the same. Each foreigner has a different background and different goals in relation to his or her property.
Accordingly, a structure that may work for one foreigner may not be appropriate for another. Although Florida real estate brokers are not required to address the U.S. tax issues raised here, they should at least recommend that foreign buyers seek the advice of a U.S. tax professional who specializes in international taxation. Proper early planning can save foreign buyers from costly surprises later.Â