Special Considerations for U.S. Real Estate
1. Income Tax
Rental income generated by U.S. real estate is fully taxable in the U.S. This means that the owner must file a tax return with the IRS and state/local tax authority. To file a tax return in the U.S., the owner must have an IRS-issued taxpayer identification number. Therefore, a consideration for an international buyer of income-generating real property is whether the buyer is willing to directly enter into the U.S. tax system. If the answer is no, then a U.S. holding company would be an appropriate choice because the holding company will be the taxpayer in the U.S. instead.
Even if the real estate is for personal use and does not generate current rental income, when the real estate is eventually sold, the capital gains are also fully taxable in the U.S. and a tax payment and filing obligation will ensue. In addition, because of the operation of the FIRPTA for international sellers, a tax equal to 15% of the gross sale price is withheld at closing unless a reduced withholding certificate is obtained from the IRS to allow for a reduced amount of withholding.
A common misconception is the use of a "personal holding company" to hold a personal-use U.S. real estate (an apartment in New York City, for example). A personal holding company does not exist in U.S. tax concepts. If the corporate structure is to be respected by the IRS, the shareholder must also respect the same corporate structure -- this means that fair market rent must be paid by the shareholder or the family members of the shareholder to use the apartment. As a result, the corporation is considered to have rental income and must therefore file tax returns and pay tax each year, hardly an ideal tax situation.
2. Estate/Gift Tax
U.S. real estate is subject to the U.S. estate tax if held directly by a non-U.S. individual at death. In addition, even if the real property is held inside a U.S. holding company, the shares of the U.S. company are still subject to U.S. estate tax. The estate tax exemption amount for a non-U.S. individual is only $60,000 and the tax rate is approximately 40%. In addition, a gift of U.S. real estate is also subject to U.S. gift tax at 40% of the fair market value of the real estate.
If a non-U.S. corporation is used to hold the U.S. real estate, there is no U.S. estate tax exposure but the rental income is subject to two levels of tax - first the regular corporate income tax at about 34% and then an automatic branch profits tax at 30% on the after-tax amount, which can render the effective tax rate to more than 50%.
3. How We Can Help
We routinely work with real estate lawyers to assist international individuals in the structuring of their U.S. real estate investments through the use of U.S. or non-U.S. trusts or holding companies to address the various income tax and estate/gift tax issues depending on whether the real estate is income generating or for personal use. We can customize the appropriate holding structure based on the particular facts and the personal preferences of our international clients.
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