Non-Resident Investors in the U.S. Real Estate Market
Tax Issues and Considerations
The United States real estate markets have seen a strong demand from foreign investors who are seeking potentially attractive investment opportunities. In addition to important and numerous logistical and risk management considerations that the investor must contend with, the tax consequences of the various available legal structures also must be carefully analyzed prior to the commencement of the investment.
Each ownership structure has advantages and disadvantages in regard to reportable income. The issue of estate taxes is also important, potentially more so than annual tax reporting. Available structures of ownership include:
- Direct ownership
- Ownership through a foreign corporation
- Ownership through a U.S. corporation
- Ownership through a partnership of LLC
- Ownership through a trust
Many questions determine what structure is best for the specific investor. For starters, what is the investor’s country of residence and is there a tax treaty in effect to improve the individual’s income and estate tax? What is the purpose of the investment; is it for personal use or solely to generate income? What are the timing considerations; long-term versus short-term holding? Is one intending to pass the property to a spouse or children?
The optimal choice for structuring investment in U.S. real estate is dependent on a variety of factors as well as the preferences of each individual investor. The complex estate and income tax rules should always be considered before deciding any investment structure and you can contact us to discuss specific tax needs.
U.S. Tax Implications for non-U.S. Investors
A non-U.S. investor (a.k.a. non-resident alien or NRA) is only taxed on the sale of capital assets that are U.S. business assets or real property interests. Any gain from the sale of foreign-source capital assets are exempt from U.S. tax. If the investor has U.S.-sourced income or is engaged in a U.S. business, they are required to file a U.S. income tax return (Form 1040-NR) unless the full tax was withheld at source.
Note that U.S. citizens and green card holders are never considered to be NRA, regardless of their place of residence and birth. If the investor holds a U.S. passport or green card, then he must report 100% of world-wide income on Form 1040 (sans NR). U.S. sourced investments are only part of the picture in this scenario. The determination of alien tax status is a potentially cumbersome issue worth of its own article. See https://www.irs.gov/Individuals/International-Taxpayers/Determining-Alien-Tax-Status or consult your tax attorney or professional to determine your status. This article is directed at individuals that are classified as NRA.
There are different tax rules and rates depending on the character of the income. In particular, there are three categories:
- Fixed and determinable periodic income
- Income from the conduct of a U.S. business
- Income from the disposition of U.S. real estate
Fixed and determinable periodic income (FDAP) includes fixed income that is paid in intervals, such as rent, dividends, interest and wages. If this income is NOT effectively connected with the NRA’s U.S. trade or business, there is a “withholding tax” at 30% of the gross income. The tax is called “withholding tax” because it is withheld at source and paid directly to the IRS by the payer and the investor does not need to file a separate report with the IRS.
Income that is “effectively connected” with a U.S. trade or business is taxed on net income (income less deductions) at the same Federal income tax rates that apply to U.S. citizens. The graduated individual income tax rates range from 10% to 39.6% and corporate income tax rates range from 15% to 35%.
Generally speaking, income from the disposition of U.S. real estate is considered “effectively connected” with a U.S. trade or business and subject to U.S. capital gain tax rates. For 2015 filing, the maximum individual capital gains rate is 20% and corporations are taxed at a flat rate of 35%.
In all cases, there can also be State tax dependent on where the property is located. It is also important to consider potential U.S. estate tax issues, and it is important to speak to a tax professional to understand all of the issues and taxation with investing in U.S. real estate.
Tax Implications Specific to Israeli Investors
A non-U.S. investor that owns U.S. property must first report and pay taxes to the U.S. In addition to paying U.S. taxes, the investor will often need to also report the income to their resident country and is potentially exposed to tax liability above and beyond that imposed by the U.S. tax authorities.
An Israeli resident with rental income from property in the U.S. has two options for Israeli Tax Reporting:
- The Israeli resident pays a flat 15% tax on the total rental income less depreciation, however cannot deduct any expenses.
- The Israeli resident pays their marginal tax rate on the net income after all allowable expenses as per Israeli tax law.
In the first option, the Israeli resident is not allowed to take a credit for the tax already paid to the U.S. (there is double taxation), whereas in the Marginal Tax Option the Israeli resident can deduct the tax already paid to the U.S. from the tax due to Israel.
Recognition of rental income and treatment of capital sales are complicated issues that need to be carefully considered within the process of investments, particularly for Israeli residents that invest in U.S. property. Please contact us to discuss your specific tax needs.