The United States is regarded as one of the most economically stable markets for investing and is considered an attractive market for real estate acquisitions. As international individuals and families look to the United States real estate market, it’s important to understand US income tax and estate tax laws, as well as other practical considerations which may affect your investment. The following discussion is intended to be a brief overview of a robust body of laws on this topic and is not intended to be tax advice. You should always seek the advice of qualified tax and legal counsel prior to investing in U.S. real estate.
The first step in planning a real estate investment in the U.S. is to become familiar with U.S. tax laws and regulations. The United States imposes an estate tax on real estate properties and other certain assets owned in the U.S. by nonresidents, upon the death of the owner. For non-U.S. residents, the estate tax applies when the aggregate value of U.S. assets is USD60,000 or more (absent the application of a U.S. estate tax treaty which may provide for more beneficial treatment).
As a non-U.S. resident investor, there are several common strategies for investment in US real estate that can avoid or mitigate the imposition of the U.S. estate tax, and it is important to work with your tax and legal advisors to determine the strategy which may be best for you. Different strategies may be more or less efficient with regard to the US tax treatment on the income earned from the investment, which also have to be balanced with protecting your heirs from the imposition of the US estate tax.
For many investors, this is as simple as purchasing a life insurance policy with a death benefit sufficient to cover the U.S. estate tax obligation. The proceeds from the payout of a life insurance policy are not considered an asset subject to the U.S. estate tax, even if paid on a U.S. life insurance policy. In addition, the benefit of this approach is that you retain eligibility for capital gains treatment when applicable (which is lost with a corporate structure) and full control which comes with individual ownership (which is lost to a certain extent with an irrevocable trust structure).
A trust may be another alternative to avoid the imposition of the U.S. estate tax on the death of the nonresident investor. If properly structured and funded, the Settlor of the irrevocable trust would not be treated as the owner of the assets owned by the trust for U.S. estate tax purposes, and accordingly there should be no imposition of the U.S. estate tax with regard to those assets on the death of the Settlor. However, to be effective, the Settlor of the trust will have to relinquish the ability to make certain decisions regarding control of the real estate to a third-party trustee (often an independent corporate trustee) so that the IRS no longer considers the Settlor the owner of the assets held by the trust.
Some advisors may alternatively suggest purchasing the real estate through a non-U.S. corporation (which typically also holds the real estate through an underlying wholly-owned U.S. corporation). By owning the U.S. real estate indirectly through a non-U.S. corporation, the owner should be able to avoid the imposition of the U.S. estate tax on the death of the owner of the non-U.S. corporation. This structure may be less efficient than individual ownership or a trust for U.S. income tax purposes, however, as corporations are not eligible for long-term capital gains treatment, and there may be both a tax on the income earned by the corporation and on the dividend paid (or dividend-equivalent branch profits tax payment). Additionally, many U.S. States impose an additional state corporate income tax on the income earned by the corporation.
In addition to the U.S. income and U.S. estate tax consequences, certain real estate transactions may result in the imposition of withholding obligations, such as the Foreign Investment in Real Property Tax Act (FIRPTA). Under FIRPTA, the U.S. imposes a withholding obligation on the sale of U.S. real estate by nonresidents (an obligation that can be potentially minimized with proper planning). The FIRPTA withholding obligation is typically 15 per cent of the gross proceeds on the sale of the U.S. real estate.
FIRPTA represents an advance withholding to ensure payment of the tax which is owed. The seller who was subject to a FIRPTA withholding will still be required to file a U.S. tax return to report the sale. FIRPTA’s withholding obligation of 15 per cent of the gross proceeds may exceed the amount of tax which would be due on sale, and consequently in some cases the U.S. tax return will reflect a refund of the excess withholding over the actual tax obligation.
The imposition of FIRPTA can be minimized or avoided in certain cases with proper planning. For example, with regard to the foreign corporate structure discussed above, if the property was held by and sold by an underlying U.S. corporation, there should be no FIRPTA withholding obligation on the sale of real estate by the U.S. corporation. Additionally, in circumstances when withholding is required, an Application for Reduced Withholding can be filed to reduce the amount of FIRPTA withholding when it can be demonstrated that the maximum tax liability on sale is less than the amount subject to FIRPTA withholding.
An investor should also consider liability protection when the U.S. real estate is not held through an entity that provides protection from liability. Umbrella insurance is one option for investors who are worried about the exposure of personal liability, which is a type of personal liability insurance used to cover claims in excess of existing policy coverage. Owning the U.S. real estate through a limited liability company may also provide protection from certain types of liabilities, even when the company is disregarded for federal income tax purposes.
Although outside the scope of this particular article, it is important to mention that gifts of U.S. real estate may be subject to U.S. gift taxes. For international families who may be considering a gift of existing U.S. real estate, or considering purchasing U.S. real estate for a family member, it is important to seek the advice of qualified tax and legal counsel prior to doing so.
Finally, we should note that this is meant as a brief overview of a robust body of laws on the subject. You should always seek the advice of qualified tax and legal counsel prior to investing in U.S. real estate.
At HSBC Private Banking, we work with families and individuals around the world on the full range of their wealth planning needs. With experts on the ground in key markets around the world, we are continuously monitoring new developments, opportunities, and changes to tax laws and regulations that may impact how you invest. As you look to the U.S. for investment opportunities, our dedicated team of Wealth Planners will work closely with you, together with your legal and tax advisors, to develop solutions that make the most of your wealth.
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As international individuals and families look to the United States real estate market, it's important to understand US income tax and estate tax laws, as well as other practical considerations (which may affect your investment).