The foreign investor will need to be concerned about three separate U.S. taxes. They are the income tax, the estate tax and the gift tax.
Â There is a U.S. income tax that is applied on annual net income which starts at 15% and can be as high as 35% for both corporations and individuals. There is a tax on capital gains from the sale of assets which is only 15% to an individual taxpayer, but may be as high as 35% to a corporate taxpayer.
There is an estate tax when a non resident alien individual dies owning U.S. real estate or shares of certain types of entities that own U.S. real estate. The first $60,000 of value is excluded. Thereafter this estate tax can be as high as 45% of the equity value of the real estate.
There is also a gift tax if a non resident alien individual gifts U.S. real estate to a third party. This can be as high as the estate tax, depending upon the value of the gift.
With all of this in mind we can review the various options of U.S. real estate ownership.
1. Individual Ownership of U.S. Real Estate.
An individual Foreign Investor may own U.S. real estate in his or her own individual name. This represents the simplest form of ownership with the least amount of paperwork involved. If it is rented out the individual owner will have to file a U.S. income tax return personally reporting the U.S. income.
This form of ownership is only chosen by a small percentage of Foreign Investors. This is for at least two reasons. The first reason is liability. The owner of U.S. real estate will be personally liable for any damages that result from that real estate. While often insurance is more than sufficient to cover such claims, most investors do not want to expose themselves personally to individual liability.
Furthermore, investors from many countries are fearful of revealing their wealth for security reasons, particularly if it is a large investment. An investorâ€™s individual name as an owner of U.S. real estate will appear in the public records where that real estate is located.
This form of ownership does however provide the best income tax benefits. The individual investor will pay tax only on the investorâ€™s U.S. income. Because of expenses and depreciation deductions, the Investor may only pay a tax from operations in a relatively small tax bracket.
The tax on the profit from the gain from the sale of the real estate will be only 15%.
If one does choose to own U.S. real state individually, the foreign individual investor may be subject to an estate tax in the event that investor was to die owning the U.S. real estate.
2. Limited Liability Company Ownership
.Foreign Investors may use an entity acceptable in every state in the U.S. known as a limited liability company. This type of company is treated as if it does not exist for U.S. tax purposes and therefore the tax consequences of owning a United States limited liability company that owns U.S. real estate is similar to the tax consequences described for the individual foreign investor above. A U.S. estate tax will apply to U.S. real estate owned by a limited liability company.
However, the big difference is that the limited liability company, as the name says, provides the investor with limited personal liability for losses related to the real estate investment.
What this means is that the individual foreign investorâ€™s personal assets are not exposed to the liabilities of the investment. The limited liability company provides for the best income tax treatment and limited liability for the investorâ€™s wealth.
3. U.S. Domestic Corporate Ownership.
The use of a United States corporation by an individual Foreign Investor who invests in the United States real estate is very limited by itself. That is because shares of stock in a United States corporation that owns U.S. real estate are also included in the foreign investorâ€™s estate, if the foreign investor dies owning those shares. Thus ownership of a U.S. corporation to own U.S. real estate does not solve any U.S. estate tax problems. It does, however, create an extra tax burden for the foreign investor in United States real estate. That is because there will be an income tax on a United States corporation on the gain of the sale of the real estate asset that can be higher than the tax on the foreign individual investor. Unlike the tax on an individual, which is limited to 15%, the corporate tax can be as high as 35%.
There is however, one situation in which investment in United States real estate by the ownership of a United States corporation does make sense. If is as follows:
Gift of Shares
If the individual foreign investor intends to ultimately make a gift of his or her shares in a United States company that owns U.S. real estate to third parties, such as family members, etc., there will be no U.S. gift tax asserted on the gift of those shares. There would have been a U.S. gift tax had the real estate been given directly. Thus, the estate tax may be avoided with no gift tax payable if shares in a United States corporation that owns U.S. real estate are transferred prior to the foreign investorâ€™s death.
4. The Foreign Corporation.
As a general rule, it is not a good idea for a foreign investor to use a foreign corporation that will then directly invest in U.S. real estate. This is because foreign corporations that invest in U.S. real estate can be subject not only to U.S. corporate income taxes but might also be subject to a branch tax equal to 30% of the foreign corporate investorsâ€™ undistributed U.S. profits.
A foreign corporation is, nevertheless, very often the investment vehicle of choice for a foreign investor that is investing significant amounts of money in U.S. real estate, such as $1 Million or more. This is because estate tax becomes a major potential liability for substantial fortunes invested in U.S. real estate and U.S. estate taxes may be completely avoided if the individual Foreign Investor owns a foreign corporation that may in turn own the U.S. real estate.
There are no estate taxes in this situation because when the Foreign Investor dies owning the U.S. real estate indirectly, the Foreign Investor only transfers to his or her beneficiaries, shares in the foreign corporation and there is no direct transfer of an interest in U.S. real estate.