Synopsis: Are you a foreign investor considering purchasing or selling U.S. real estate? If so, it’s crucial for you to understand the intricacies of these transactions in order to avoid traps and complications that catch many foreign investors, and greatly reduce your U.S. tax liabilities. Some important considerations include how taxes can make or break your investment, financing hurdles, and obtaining a green card through the EB-5 program.
FINANCING THE TRANSACTION
As a foreign investor looking to buy U.S. real estate, you’re likely pursuing an all cash transaction because financing is harder to obtain due to stricter underwriting requirements, a smaller investor pool and the added difficulty of verifying the borrower’s proof of funds and financial history. However, financing is not impossible. There are several portfolio and correspondent lenders that offer loan products to foreign investors, though most are with a lower loan-to-value ratio (say 50% to 60% of the property value) compared to the typical 80% on a traditional loan. One of the largest hurdles on the financing side may be the investor country’s regulations or currency controls. Many lenders will want to see the cash equity that an investor is putting down in the borrower’s account for at least 60 days.
Under the Immigration and Nationality Act, foreigners who invest at least $1,000,000 in creating a new U.S. business or expanding an existing one are eligible for a conditional green card. The business must employ at least 10 U.S. full-time employees, produce a service or product, and benefit the U.S. economy. The foreign investor must be actively engaged in the company. There is an exception to the $1,000,000 minimum investment if one invests at least $500,000 in a Targeted Employment Area, that is, a high-unemployment or rural area. Several regional centers exist to serve investors in facilitating and meeting these requirements. It should be noted that the EB-5 investor’s primary focus is on obtaining a visa/green card, and not a return on investment. Be sure to consult an immigration attorney for more information.
INCOME TAX CONSIDERATIONS
An individual who is a nonresident alien for U.S. income tax purposes (generally, someone who does not hold a green card or live in the United States) will have to pay U.S. income tax if they rent out their U.S. real estate. The tax is generally 30% of the gross U.S. rental income. However, The Wolf Group advises its clients to consider making an election which allows the nonresident alien to take advantage of deductions and be taxed at marginal tax rates on their net U.S. rental income. Making this election will often greatly reduce, or even eliminate, the U.S. income tax liability from most residential rentals.
When selling a property in the United States, a nonresident will be subject to tax on any capital gains earned, generally at a rate of 15%-20%. This rate will also change based on whether the property has ever been rented out. Certain exceptions apply when the property sold has been used as the individual’s main home for a specified time period (however, a taxpayer in this case may also become a U.S. income tax resident subject to worldwide taxation).
To complicate matters further, there is also a Foreign Investment in Real Property Tax Act (FIRPTA) withholding, up to 15% for foreign individuals (as of February 16, 2016), which is the liability of the purchaser or purchaser’s representatives to withhold and remit to the IRS. Again, some exceptions apply, and it is possible to apply to the IRS for a reduction in the withholding amount or to obtain a refund of any excess withholding by filing a U.S. income tax return. Certain states (for example, Maryland) also have a similar withholding tax regime. Be sure to consult your tax accountant for more information.
Foreigners who are considering applying through the EB-5 program described above should also be aware of the U.S. income tax consequences of obtaining a green card. Green card holders are U.S. income tax residents who are taxed in the U.S. on their worldwide income. Additionally, they will be required to file detailed foreign information reports to the IRS regarding their assets and income outside the United States.
Estate and Gift Tax Considerations
One of the most serious considerations for a nonresident alien looking to buy U.S. real estate are the U.S. estate tax implications upon death. When a nonresident alien owns property in the United States, they will be subject to U.S. estate tax on the value of any U.S. real estate they own at the time of their death. The U.S. estate tax exemption for nonresidents is only $60,000, and the estate tax rate can be as much as 40%, so the estate tax consequences can be severe. Many states also charge an estate tax on the state level.
Similarly, gifting U.S. real estate can result in substantial U.S. gift tax liabilities for a nonresident alien. Purchasing property for, or transferring property to, a loved one may result in gift taxes up to 40% of the property’s value!
The bottom line is that a solid team of professionals is crucial to establishing the proper real estate investment strategy for a foreign investor. The Wolf Group has assisted hundreds of clients with sound tax planning for their real estate investments. Please contact our New Client Lead, Fan Chen, at firstname.lastname@example.org, or at (703) 502-9500 to discuss how to make the most ideal tax decisions for your next acquisition.
JLC & Associates is a boutique law practice in New York, NY, specializing in real estate and contract law. For assistance, please contact them at email@example.com or at (212) 380-6316.
Taxation for Nonresidents with U.S. Rental Income
Taxation of Nonresidents’ Investment in U.S. Residential Real Estate
Real Estate Investment Trusts and FIRPTA Withholding
Disclaimer: This articles in this newsletter is not intended as legal or tax advice, and cannot be relied upon for any purpose without the services of a qualified tax professional.