Foreign Nonresident Investment in US Real Estate - The IRS Tax Rules

By Kyle Lodder, CPA

The purchase of U.S. real estate has been a long-time attraction for non-U.S. investors, often due to purchasing beautiful property at stable market prices.

Careful planning should be done before acquiring U.S. real estate in order to avoid unexpected tax consequences down the road. Among the items that should be considered are:

• The expected use of the property (primary residence, vacation home, rental property, investment property, development property or a combination of these uses),
• Citizenship and residency issues,
• Use of a corporation, partnership or trust for holding the property,
• Tax issues in both U.S. and resident countries, and
• The ultimate disposition of the property

Individuals who are not U.S. citizens and not U.S. residents are considered to be nonresidents for U.S. tax purposes. If an individual does not have a U.S. green card and spends less than 120 days in the U.S. annually, generally such a person will be a nonresident.

Nonresidents are subject to U.S. taxation only on their income sourced in the United States. If a nonresident purchases U.S. real estate and uses the property for personal use only, he or she is not required to file a U.S. income tax return in any year except the year of sale. If the property is used as a rental, the owner would be subject to tax on the rental income earned, and tax returns would be required even if there was a net loss from the rental activity.

When a nonresident chooses to sell U.S. real property, the gain from such a sale is usually subject to capital gains tax in the U.S. (capital gain treatment is generally not available to property developers). Currently the capital gains tax rate for nonresidents is 15 - 20%, although the gain may be completely tax-free if the gain from sale is minimal.

Withholding tax of the gross sales proceeds, typically in the amount of 15%, may be required upon the sale of the property. This withholding tax may be exempt, reduced or eliminated in certain situations. Any required withholding tax is credited against the federal tax liability computed on the nonresident federal income tax return.

If a nonresident were to die while owning U.S. real estate, the value of the real estate in excess of $60,000 would be subject to U.S. federal estate tax. Certain credits and treaty provisions exist to decrease the burden of this tax. Potential U.S. estate tax is a risk which must be properly weighed.

State taxes should also be considered. Many states impose an income tax, withholding tax upon sale and an estate tax. If a property is used as a rental, the nonresident will be required to file and pay state income taxes in addition to the federal taxes.

When considering purchasing real estate, the foreign investor should consider the use of a corporation, partnership, or trust as an entity type to own the property. There are advantages and disadvantages for each entity type, and the pros and cons need to be explored.

Owning U.S. realty through a foreign corporation generally shields the nonresident owner from the U.S. estate tax. However, corporations do not have the benefit of the lower preferential capital gain tax rates only available to individuals and certain trusts, and any gain from the sale of the property would be subject to corporate tax rates (currently a 35% maximum rate).

The use of a foreign or U.S. partnership to hold U.S. real estate may also be an option for certain foreign investors. The gain on the sale of real estate held by a partnership would be taxed to its individual partners at the lower capital gain tax rates. In certain circumstances though, the ownership of real estate through a partnership could potentially still leave the foreign owner exposed to U.S. estate tax.

Although the use of a U.S. limited liability company (“LLC”) is a common entity type for U.S. persons to own real estate, it can be advisable for foreign investors to steer clear from owning U.S. real estate through an LLC. This entity structure is generally tax inefficient due to differences in the U.S. and foreign tax law. This is especially true for Canadian investors.

Certain trusts can offer the benefits of the lower capital gain rates upon the sale of the property, and shelter the beneficiaries from U.S. estate tax. Such trusts must be foreign irrevocable trusts and require strict limitations on ownership and use of the property. This option is less desirable for many investors due to both giving up control of the property along with the complexity and administrative hassle of the arrangement.

There is not a one-size-fits-all solution for buying U.S. realty. Each investor is unique requiring balancing of many factors, including the owner’s intended use of the property, duration of ownership, plans for future disposition, and legal liability.

This communication contains general information. Each individual investor should discuss their specific situation with a professional advisor before deciding on any investment structure.

If you require additional information on any aspect of these complex rules, please contact Kyle Lodder at 360.599.4340 or kyle@loddercpa.com. Kyle Lodder is a Certified Public Accountant and is the owner of Lodder CPA PLLC, a U.S. international tax firm. Kyle has the experience and knowledge to help foreign investors weigh the benefits and risks associated with the different investment options.

The material appearing in this communication is for informational purposes only and should not be construed as legal, accounting, or tax advice or opinion provided by Lodder CPA PLLC. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials have been prepared by a professional, the user should not substitute these materials for professional services, and should seek advice from an independent advisor before acting on any information presented. Lodder CPA PLLC assumes no obligation to provide notification of changes in tax laws or other factors that could affect the information provided.