Tax Planning for Non-U.S. Investors
Acquiring U.S. Real Estate
[CAVEAT: The U.S. Estate and Gift Tax regimes have been revised beginning January 1, 2011. In general, these revisions provide generous advantages over the old law for U.S. persons (citizens and residents (domiciliaries)). To a large extent, these advantages do not extend to non-U.S. persons, except that the top tax rate for Estate and Gifts has been lowered from 45% to 35% for everyone. In addition, some of the benefits brought by the new 2011 revisions also extend to non-U.S. persons who are resident in certain countries (16) with which the U.S. has an Estate and/or Gift Tax Treaty. The treaties with these 16 countries are not uniform in their benefits and in many cases, the Treaty benefits provide no greater advantage over the general U.S. Estate and Gift laws applicable to foreign persons resident in countries with which the U.S. does not maintain any Estate or Gift Tax Treaty.
Importantly, these new revisions to the Estate and Gift Tax apply for only two years. Unless new federal legislation intervenes in the meantime, on January 1, 2013, the tax rate will revert to the 55% rate and the exclusions in place prior to 2001. Because of the continued adverse impact of the Estate and Gift Tax on non-U.S. persons, foreign investors in U.S. real estate should seek competent tax counsel prior to closing to implement prudent tax planning based on the client’s specific facts and circumstances.]
GENERAL:
While most non-U.S. investors are aware that they are subject to income tax on the sale of property located in the U.S., most probably do not realize that they are subject to other very onerous U.S. taxes, the gift tax and the estate tax, when they transfer property other than by sale. Whereas it is often advisable for an U.S. couple purchasing real to take title to property in their names either as joint tenants or as tenants in common, doing so by a foreign investor can have disastrous estate tax consequences that could be avoided with proper planning before closing.
U.S. Gift Tax: Non-U.S. owners of real estate are subject to a transfer tax on a gift of property made, for example, to a child, spouse or other person. A gift can even occur by simply adding a child to the title for a property. Essentially, a gift is made if the owner does not receive fair compensation in exchange for the property.
U.S. Estate Tax: Non-U.S. owners of U.S. real estate are also subject to a transfer tax on the transfer of property that arises from the death of the owner, such as, when it is conveyed to an heir.
It is important for non-U.S. investors to understand the basic difference between the income tax and the gift and estate tax to appreciate that the gift and estate tax is far more serious for them than for U.S. investors, and most importantly, to understand that these transfer taxes can be avoided or minimized with proper advance planning.
There are several critical issues for non-U.S. purchasers of U.S. real estate to understand:
(i) The income tax is assessed only on the difference between what a property is purchased for and what is sold for (with some adjustments). This is just a fraction of the total property value, usually based on the appreciation in value.
However, U.S. gift and estate taxes are assessed on the total value of U.S. property at the time of gift or death, not just on the difference between the purchase and sale price.
(ii) Gift and estate taxes are generally higher for non-U.S. owners than for U.S. owners because certain generous exemptions and credits against these taxes are far more limited for them than they are for U.S. persons.
(iii) Gift and estate tax rates.
Most non-U.S. persons are entitled to an exclusion of only $60,000 in property value from the U.S. estate tax while there is no exclusion for gifts to non-U.S. persons (except a $136,000 annual exclusion for gifts made to a non-U.S. spouse). Moreover, there is no significant deduction from the property value for a conventional recourse mortgage securing the property. U.S. gift and estate tax rates are progressive and for 2011 and 2012 range from 18% to a maximum rate of 35% on properties with a taxable value of $500,000 and higher. Since non-U.S. persons typically invest in properties in value of more than $500,000, the maximum rate will likely apply. Whereas it is often advisable for an U.S. couple purchasing property to take title in their joint names, doing so by a foreign investor can have disastrous estate tax consequences which can be avoided with proper planning before closing. For example, in regard to real estate valued at $5,000,000, the estate tax for a foreign person dying in 2011 or 2012 could be as much as $1,729,000, even with mortgage securing the property, whereas the Estate Tax for a U.S. owner owning a similar property would be $0.
Kevin J. Mullin, J.D., CPA, LL.M. (International Taxation),has been practicing law for over 20 years with a focus on advising foreign investors on their U.S. real estate and other investments, and international business, estate and tax planning. Caveat: In no event should any acquisition, operation, transfer or other disposition of U.S. property or real estate be undertaken without competent tax advice based on the investor’s particular facts and circumstances and the availability of any income, estate, of gift tax treaty benefits. This article does not contain all of the rules and exceptions relating to the subject matters contained herein and is for general informational purposes only. Accordingly, no action should be taken or withheld based on the information provided. This material is presented with the understanding that the author is not rendering any legal, accounting, or other professional service. In no event will the author be liable for any direct, indirect or consequential damages resulting from the use of this material. IRS Circular 230: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document (including any attachments) is not intended or written to be used, and cannot be used for the purpose of (i) avoiding any penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this document. ©Kevin J. Mullin 4/11