A foreign investor may own U.S. real estate directly in their name. However, this is the most form of ownership that exposes the owner to estate taxes, gift taxes, personal liability, income tax reporting requirements, and Foreign Investment in Real Property Tax Act (“FIRPTA”) withholding tax.
It’s an expensive oversight not to claim bilateral tax treaties when purchasing U.S. real estate.
The U.S. has tax treaties with 68 countries. Under these treaties, foreign residents are taxed at a reduced rate or are entirely exempt from U.S. taxes on certain items of income they receive from real estate investment activities.
From our experience, most foreign buyers fail to claim tax treaty benefits when investing in U.S. real estate due to a lack of proper legal advice or following advice widely available on the Internet.
The impact of tax treaties can be pretty significant for the foreign buyer’s bottom line, substantially reducing U.S. income, gift, estate, and withholding taxes. Foreign investment must be carefully structured and documented to benefit from tax treaty provisions. For example, the U.S. has tax treaties with 30+ countries, which would allow buyers from these countries to pay a reduced tax rate on rental incomes distributed as dividends.
A 30% (or lower treaty) tax could apply to rental income distributed as dividends to a foreign investor. With proper structuring and relying on tax treaty provisions, an investor from Venezuela could reduce this rate to 5% (instead of 30%) when repatriating the rental income profits.
Some of the countries with preferential dividend/rental income distribute tax rates:
Venezuela
Kazakhstan
Philippines
Hungary
Turkey
Thailand
Germany
Indonesia
India
Italy
United Kingdom
Vietnam
Uzbekistan
For example, the U.S. has gift tax treaties with Germany, Japan, the United Kingdom, France, Australia, and Austria. A foreign investor from these jurisdictions could rely on preferential gift tax exemption when gifting an interest in U.S. real estate. U.S. does not have estate and/or gift tax provisions with Turkey.
With proper planning, the tax savings could be pretty significant, allowing effective tax rate reductions of up to 70-80%, making a foreign buyer’s investment in U.S. real estate much more attractive.
Depending on the investor’s objectives, in some cases, an optimal structure for foreigners investing in US real estate is through a US Blocker Corporation Structure which involves a US blocker corporation classified as a C-Corp for the US income tax purposes.
In turn, the foreign investor acquires stock in a foreign corporation that invests in a US blocker corporation, which buys US real estate. With proper structuring, the investor may be able to optimize capital gains upon sale of US real estate, eliminate taxation upon death and eliminate FIRPTA.
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