US Tax Planning for Foreigners Owning US Real Estate (2024)

Tax Implications for Foreigners Owning United States Real Estate

Tax Planning for Foreigners Owning United States Real Estate: US Real Estate in general is a relatively safe and easy investment to maintain for nonresident aliens — aside from the headache that is FIRPTA. Unlike various other foreign countries which require citizenship or permanent residency in the country, the United States does not require much byway of real estate ownership — other than the fact that there are tax requirements for foreigners such as FDAP or ECI. When a Foreigner plans to own real estate in the United States, it is very important that they understand the tax implications before acquiring the asset — because the rules are different than other types of US investments. For example, while US-sourced Capital Gains and Interest Income is typically not taxed to foreigners — both rental income and the sale of US real estate is taxable — as well as possible transfer taxes for gifts made by non-US persons of US situs. In recent years, the Internal Revenue Service has significantly increased enforcement of foreigners investing into the United States — and that includes ownership of US real estate. Therefore, foreigners who are planning on owning US Real Estate should be aware of the different tax implications and how to best plan ahead. Generally, foreigners should consider speaking with a Board-Certified Tax Law Specialist first before making any investment into US real estate unless they already have a solid tax understanding of what the implications will be. Let’s look at the basics of Tax Planning for Foreigners.

Introduction to Tax Planning for Foreigners Planning to Own US Real Estate

When a foreign person owns US real estate, there are different US tax issues to consider. That is because the Internal Revenue Service wants to ensure that the foreigners (nonresident alien ) are “motivated” to pay taxes. Otherwise, when a foreign person owns US property that earns rental income or capital gains at the time of sale — they will be able to sell the property under the nose of the IRS — and avoid US tax altogether. Unlike other types of capital gains that may be exempt from US tax on sale — the sale of US real estate is taxable.

Individual vs LLC Real Estate Ownership

The primary benefits of holding real estate in an LLC is to provide the foreigner who rents out the property with some protections in the case of lawsuit. An SMLLC (Single-Member LLC) is by default a flow-through company — so the mere ownership of US property by a foreigner in an LLC will not change the tax consequences without further elections being made (for example, electing to be treated as ECI instead of FDAP). But, the LLC can then more easily obtain insurance and other protections as opposed to a foreigner with no ties to the United States.

Tax Planning for Foreigners Renting US Real Estate Property

Rental income is by default categorized as FDAP — which refers to Fixed, Determinable Annual and Periodic. When a Nonresident alien earns FDAP income it is withheld at the 30% flat tax rate — and, the taxpayer is not permitted to take deductions — which generally would defeat the purpose of owning US based real estate. In order to avoid this lopsided outcome, the nonresident alien can elect for the rental property to be treated as effectively connected income (ECI) — and the nonresident would then be able to claim all the deductions associated with the real estate rental income. The income is then taxed at the progressive tax rate based on the amount of income.

Selling US Real Estate by Foreigners

In general, US capital gains are not taxable to nonresident aliens. Rather, capital gains are considered sourced at the location of the Taxpayer. This general rule does not apply to individually owned US real estate by a foreigner, non-resident alien. Individually owned real estate is taxed on the sale as capital gain. Thus, the nonresident alien determines the value of the real estate on the date acquisition — and the date of sale — and then pays capital gains tax on the difference of the acquisition price and sale price. In order for the United states to track the sale of US property owned by foreign nationals – FIRPTA was introduced. FIRPTA is the Foreign Investment in Real Property Tax Act. It requires a 15% withholding of the sale price (not the perceived gain) to be deposited with the US government pending the completion of the sale — this is to ensure that the foreign national files a U.S. tax return and pays any capital gain income.

Nonresident aliens may be able to circumvent FIRPTA withholding requirements by filing for a withholding certificate to eliminate or reduce the withholding.

Tax Planning for Foreigners Transferring Real Property by Nonresident Aliens

There are some tax traps for nonresident aliens involving the ownership of US real estate as well (and some of it overlaps with ownership of other tangible US property as well). When a nonresident alien transfers ownership of US real estate, there is an immediate gift tax on the transfer (minus the annual gift/estate tax exclusion) — which is different than most gifts in which the tax does not take effect until after the transferor passes away. Likewise, if a nonresident alien owns US property and then passes away, there is only a $60,000 exemption on the amount of US assets — this is in sharp contrast to US persons who receive upwards of $11 million exemption on their worldwide property and assets (subject o change).

This is why planning is crucial for nonresident alien foreigners who plan on acquiring US real estate.

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