Rising U.S. real estate prices and a stable political system are a couple reasons why more and more foreign individuals are investing in U.S. real estate. But when considering buying property in the U.S., different ownership options will yield different requirements as well as varied tax results. Below are three ownership options from which to choose and their income tax obligations to consider.
Option #1 – Direct Ownership
Direct ownership is probably the simplest option, as it does not involve forming a separate company in which to hold the property. Direct ownership provides the benefits of a single layer of U.S. tax and preferential capital gain rates if the property sells for a gain in the future.
However, if the property is considered a trade or business (such as a rental property), the foreign owner is required to file a U.S. tax return and pay tax on related income (if any). Even if no income tax is due, nonresidents often prefer not to file a U.S. personal income tax return for privacy reasons. In addition to the concern over this tax compliance responsibility, owning U.S. real property potentially subjects the nonresident to U.S. estate tax.
Option #2 – Ownership Through a U.S. Corporation
Owning real estate through stock in a U.S. corporation can serve as a “blocker” by providing privacy to the foreign person, as he or she would not be required to file a personal U.S. tax return. Instead, the U.S. corporation is required to file a return. Additionally, the structure benefits nonresidents who are concerned about becoming subject to U.S. estate tax, since nonresidents are not subject to U.S. estate tax on U.S. intangible property they own (such as stock in a U.S. corporation).
However, the presence of a U.S. corporation means that any income or gains on a sale would be taxed at corporate income tax rates as high as 35%; the preferential capital gain tax rates are not available to C corporations. If income is distributed to the foreign person, the U.S. may withhold tax on these amounts. The amount of the withholding will depend on the tax treaty between countries, if any. In addition, transfers of the U.S. corporation stock are potentially subject to U.S. gift tax, even though the shares are exempt from U.S. estate tax.
Option #3 – Ownership Through a Foreign Corporation
Ownership through a foreign corporation provides many of the same considerations as ownership through a U.S. corporation. The foreign person would not be required to file a personal tax return and not have U.S. estate tax concerns. Any income or gains on the sale would be taxed at corporate rates, and an additional branch profits tax will apply. One difference, and benefit, is that stock in a foreign corporation held by a foreign person is not subject to either U.S. gift or estate tax.
In addition to the U.S. tax concerns, it is always advisable in cross-border tax situations to consider how the foreign jurisdiction will treat the transaction. The goal should always be to minimize worldwide taxes – not just U.S. tax.
There is no one ownership structure that would alleviate all of a foreign person’s U.S. tax concerns. The ultimate ownership decision is going to depend on which income tax requirements the foreign investor deems most tolerable. Consequently, the best structure will often depend on the particular fact pattern.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.