Investing in US Real Estate as a Foreigner

A lot of our clients from other countries own U.S. properties or shares in companies that own U.S. properties. These properties can be homes, offices, apartments, farms, vacant land, or places with resources like minerals or oil. These can produce income that may be subject to U.S. income tax in the year it's received. Additionally, when these U.S. properties are sold, the owners may have to pay taxes on their profit, also known as capital gains.

According to international law, the U.S. has the right to tax this income because the property is located within the U.S. Profit from the sale of properties and specific payments from companies that own U.S. property are taxed according to the Foreign Investment in Real Property Tax Act of 1980. This tax is typically taken from the source of the income.

Rental Income

Foreign clients who make money from renting U.S. properties usually have to pay 30% tax. This tax is taken directly from the income they earn. However, if the income is linked to a U.S. business or if certain tax rules apply, they may pay less.

Taxes aren't reduced even if there's a U.S. tax treaty. Normally, these clients don't need to file a U.S. tax return because this tax is meant to cover all related costs. But for certain properties, like real estate or mineral properties, the expenses can be high. Here, the clients might end up paying more tax than they're earning. To avoid this, they might choose to be taxed based on their net income, not the total amount they earn.

Non-U.S. residents who make money from U.S. properties can choose to treat all this income as if it's tied to a U.S. business. This income can come from selling properties, rent, or resources like timber, coal, or iron ore. Foreign companies can also do this.

By making this choice, the income is taxed based on the net income, not the total amount earned. This allows clients to reduce their tax by claiming certain costs, like property depreciation, insurance premiums, maintenance costs, and real estate taxes. This can greatly reduce or even remove the tax they need to pay.

Once a client chooses this, they can't change it unless they get permission from the Service. If they do change their mind and later want to switch back, they also need permission and should include this decision in their federal income tax return.

Disposition of Real Property

The FIRPTA rules deal with how non-U.S. individuals or companies are taxed when they sell U.S. property or get money from certain types of companies that hold U.S. property. This includes making sure taxes are taken from these transactions. This applies even if the money made is not connected to a U.S. business.

According to FIRPTA, any non-U.S. person or company that sells U.S. property or gets money from certain types of companies holding U.S. property needs to pay U.S. income tax on the money they make. FIRPTA applies to these situations:

1. A non-U.S. person selling property;

2. Certain U.S. companies giving money to non-U.S. shareholders;

3. A non-U.S. company giving property to a shareholder;

4. A U.S. partnership with a non-U.S. partner selling property;

5. Any partnership giving out property;

6. A non-U.S. company selling property; and

7. A non-U.S. trust selling property.

However, this tax doesn't apply if the property is swapped for another U.S. property of the same type. But, swapping a U.S. property for a non-U.S. one won't delay U.S. income tax, because the non-U.S. property could then be sold without affecting U.S. income tax.

Withholding Amount

The rule states that when a non-U.S. resident sells a property located in the U.S., 15% of the total sales price or amount distributed from a USRPHC has to be withheld. However, if an approval for reduced withholding is obtained from the Service, this amount won't go beyond the seller's maximum tax liability. So, if a foreign client sells a U.S. property and the resulting tax bill is much lower than the 15% that's usually withheld, it may be worthwhile to get this approval. This can improve the client's immediate cash availability.

This 15% rate was established by the PATH Act in 2015 and is applicable to property sales after February 16, 2016, according to the law and final regulations. Sales that happened before that date had a lower withholding rate of 10%.

One Exception to Consider

The American Jobs Creation Act of 2004 and the PATH Act have outlined rules that exempt certain capital gains from a real estate investment trust (REIT) from being classified as income connected to U.S. operations for non-U.S. residents. This exception applies if the investor doesn't own more than 10% of a specific class of stock that is frequently traded on a U.S. securities market, throughout the year before the date of distribution.

When these conditions are met, the non-U.S. investor isn't obligated to file a U.S. federal income tax return simply because they've received a REIT distribution. Instead, this distribution is regarded as a regular dividend rather than a capital gain. However, this FIRPTA exception doesn't apply to regulated investment companies (RICs).

Any REIT distributions to foreign shareholders that don't meet these requirements will still be considered as gains from selling U.S. real estate and taxed under FIRPTA based on the shareholder's proportionate share of the REIT's net capital gain from selling U.S. real property interests. But, if a REIT is primarily owned by U.S. residents, foreign shareholders aren't subject to FIRPTA tax on the sale of the REIT's shares, with the exception of REIT distributions. This means that a stake in a U.S.-controlled REIT isn't considered a U.S. real property interest.

Next Steps

If you’re considering acquiring real property in the US and would like further guidance on how to best achieve this from a tax perspective, please reach out to us!