Foreign investors who sell US property must pay the Foreign Investment Real Property Transfer Act Withholding Tax of 15% as withholding tax and then have it credited back upon filing their US income tax returns.
An individual investor typically finds the use of an LLC as the best solution to hold real estate. This strategy offers anonymity while protecting personal assets from becoming subject to US estate taxes upon death.
1. FIRPTA
If you own property in the US and are foreign-national or company, the Foreign Investment in Real Property Tax Act (FIRPTA) should be familiar to you. Under this legislation, when purchasing US real estate from buyers who are non-US nationals or companies, buyers are required to withhold 10% (if an individual) or 35% (if a business entity) of its selling price as withholding for IRS. Ultimately this withholding will be returned back if taxes for the year in which your sale are filed successfully.
FIRPTA was passed into law in 1980 to prevent foreign investors from purchasing and then selling American real estate without paying capital gains taxes, and to address concerns that these foreign investors were receiving an unfair advantage over US counterparts by buying and selling real estate without incurring tax obligations to the federal government.
Determining whether FIRPTA withholding applies to a particular sale relies heavily on whether or not the seller qualifies as a "Foreign Person." According to the IRS, this term encompasses any nonresident alien who does not claim green card status or citizenship and any entity not treated as domestic corporation.
If you are selling property jointly as husband and wife, typically only one spouse's share will be subject to withholding from FIRPTA taxes. However, this may not always be the case and you should consult with an experienced US tax CPA to ensure you comply with all FIRPTA requirements.
There may also be instances when a sale won't fall under FIRPTA withholding requirements, like short sales. To prevent FIRPTA withholding from being applied during sales process, sellers should apply for an Individual Tax Identification Number (ITIN) from the IRS to avoid having any withholding taxes applied against them during this process. It can be an intricate procedure so professional assistance should be sought to avoid penalties from the IRS - an experienced tax CPA should provide all the relevant details regarding FIRPTA withholding requirements and deadlines.
2. State Taxes
State taxes are an integral component of US taxation and often just as significant. They fund municipal services like schools, garbage collection and water and sewer maintenance. Property and sales taxes tend to have a more profound effect on low-income Americans than wealthier ones, which can be seen by the large chart at the top of this page that displays average state and local tax burden by income group. Below are three smaller charts which highlight state averages for sales and excise taxes, personal income taxes and property taxes in each state. Indirect consumption taxes - business-level taxes that are passed along in higher prices to consumers - are also covered in this report.
Foreign individuals investing in US real estate structures generally face capital gains tax similar to any other investor; however, with careful structuring they may be able to reduce or even avoid this tax entirely.
If a foreign person acquires rental property in the US, their income is subject to US income tax at current US rates as well as potentially 30 percent branch profit tax (unless an income tax treaty reduces it). By structuring their transaction carefully and correctly, they may be able to reduce or even avoid these taxes altogether.
Most international investors prefer investing in US real estate through a limited liability company, rather than directly under their own name. This provides for better tax planning as it ensures separation of investments and personal assets from each other and an improved tax planning experience.
Fairness in tax systems depends on both its composition of broad tax types and on how the structures governing each are designed and administered. While state and local taxes can be highly regressive, lawmakers can still make adjustments that make their systems more equitable; according to this report's results, some states have taken steps towards rectifying such trends; however, overall this tax system remains highly regressive for lower-income taxpayers.
3. Local Taxes
Foreign individuals do not face income taxes when purchasing US real estate, however local tax laws can make the investment more costly. Most localities impose property taxes depending on whether a building is residential or commercial property and often collect sales taxes as well; this allows local governments to tailor tax rates according to constituent needs; for instance many states levy higher sales taxes on certain goods like alcohol to fund public safety initiatives.
At the local government level, most rent-paying tenants must pay withholding tax equivalent to 30 percent of gross rental payments unless an income tax treaty reduces it further. Furthermore, property owners in such localities have access to various deductions available to them such as mortgage interest deductions, management fees/ expenses/ depreciation/ local property taxes as well as potential capital gains exemptions on certain types of real estate investments.
Before investing in US real estate, investors must understand their individual tax requirements. A variety of different taxes could apply and they must ensure their investments comply with all relevant laws.
Therefore, investors should seek professional assistance from experienced tax professionals in both their home country and the US in order to stay compliant with all laws applicable to US real estate investments and maximize returns from their investments.
Investors with complex tax situations should seek the advice of both an accountant and real estate lawyer, both locally and in the US, prior to investing in US real estate through an LLC or trust structure. Doing so can reduce taxes while protecting against unexpected events with potentially disastrous financial implications; furthermore, protecting their rights and interests during a potential future sale transaction is also key.
4. Income Taxes
Income taxes should also be taken into account by foreign investors when investing in US real estate, alongside property taxes such as FIRPTA. When renting out their properties to tenants, foreign investors are subject to IRS reporting on rental income as part of an annual tax return and may need to withhold taxes from tenants for withholding purposes. They may also be able to deduct eligible expenses such as mortgage interest payments, management fees and expenses, local property taxes and repairs costs among others.
Foreign investors selling property must pay capital gains tax on any profit realized from selling according to their tax status in the U.S. and nature of disposition. Furthermore, the Foreign Investment in Real Property Tax Act (FIRPTA) rules require 15% of sales price be automatically withheld, unless an exemption exists.
Withholding tax amounts are intended to bring forward any future tax liabilities of sellers; therefore, if a sale resulted in profit for foreign investors it is generally advised they file US tax returns and request a refund for withholding taxes withheld from them.
Foreign investors who own properties through business structures such as corporations or land trusts may be eligible to take advantage of certain tax benefits. Selecting the ideal holding structure depends upon factors like income generation potential, repatriating earnings back home, exit strategies from an investment and other considerations.
As there is no one-size-fits-all approach to US taxation of foreign real estate investments, careful planning is required in order to navigate its complex tax system successfully. Timo Becker is an experienced international tax attorney with expertise assisting foreign nationals invest in US investments that comply with US laws and treaty provisions; additionally he helps individuals and businesses comply with their US income tax compliance needs as well. For assistance navigating his services schedule a consultation appointment today!