Tax considerations
for overseas investors in USA real estate.
The tax laws
on overseas investors in US real estate are sophisticated. Make sure you get competent
professional advice before you make an investment. The following is a brief overview.
Income taxes
If you rent our your real estate investment
your income will be taxed.
You can elect to have the gross income
taxed at a flat rate or file a tax return. The flat rate will be at 30% (but you may get
some help from tax treaties to prevent taxation twice on the same income). The flat rate
option will not allow you to deduct expenses such as maintenance, mortgage interest,
electricity or water. The US person who withholds the tax must file an annual Form 1042
and 1042S.
Or it can be taxed as effectively connected
US source income. Then you will have to file a 1040NR tax return but will be able to
deduct for expenses associated with that income. This option is the sensible choice unless
the income you generate is very low.
Under US tax law, you can depreciate the
property, there are different rates for residential and commercial properties. This annual
depreciation is deducted from your income as an expense on your tax return. But it will be
recaptured when you sell. See below.
If you invest in mortgages secured on US
properties, your income will also be subject to tax. This would be subject to tax treaties
that are intended to avoid double taxation. If the lender is from a country that does not
have a tax treaty with the United States, withholding tax should be deducted at the
appropriate rate, usually 30%. However it is possible for mortgage income to be
characterized as portfolio income that is not subject to withholding tax. See page 14 of
IRS publication 519 (see below) and a GOOD international tax attorney.
Capital gains taxes
Unlike many countries, such as the UK, the
US government also wants it's share, or more than its share, when you sell the real
estate.
There is an especially nasty law
called FIRPTA. (Foreign investors real property tax act.) The US government is
very worried you will sell the property and skip the country with the money. Under FIRPTA,
the US persons handling the transaction is required to withhold 10% of the GROSS price,
even if you have not made a profit. It is possible to get an advance clearance from the
IRS, but allow several months.
There is an exclusion to this, which the
closing agent may not be aware of. That is if the property is sold for less that $300,000
AND the buyer (or family member) is going to use it as a personal residence. See the Act
for the exact requirements. Then no withholding tax need be deducted. But you will still
have to pay capital gains tax if it is owing.
The rate of capital gains tax is is
slightly higher on the re-captured depreciation element of your gain.
If FIRPTA applies you can reclaim any
excess deducted by making application to the IRS. Again allow several months.
Estate taxes
Variously known as death duty, inheritance,
capital transfer taxes. Here the non-resident gets far worse treatment than the US citizen
or permanent resident.
The US citizen has a 100% allowance on
bequests and gifts to their spouse and very generous limits on transfers to other parties.
But this drops to just $10,000 if you are
foolish enough to be a foreigner who dies while owning US real estate. There may be some
sort of relief through double tax treaties.
The estate taxes also apply to mortgages
secured on US properties.
To download a copy of the IRS publication
519, US Tax Guide for Aliens, click
here.
To download a copy of the IRS
publication 515, which covers withholding taxes from non residents, click here.
Again, the
subject of overseas persons investing in US real estate can be a minefield. The above is
intended to be accurate but is not guaranteed or intended to replace competent
legal and tax advice from professionals in this field.
Tax Changes and Effects
The new capital gains law allows homeowners to avoid paying taxes on the first $500,000 of
profit if they are married or on the first $250,000 if they are single. You must have
lived in the home as your primary residence for two of the last five years. You are
allowed to use the provision as often as you like, as long as it fits in that two year
period. Any gains above the limit will be taxed at the new 20% capital gains rate - down
from the current 28 %.
The old law provided a $125,000 "one time" tax free exclusion on profits for
home sellers 55 or older. This no longer is used, but those who have used it will be
allowed to use the new provisions without penalty. Under the old law you could roll over
gains if you bought a more expensive house. If you sold a more expensive one and purchased
a less expensive one you were liable for gains tax. Under the new law this provision is no
longer in effect.
Time Frames
If you bought and sold a home within 1 year, any capital gains would be taxed as regular
income. If bought and sold between 1 and 2 years, gains would be taxed at the long term
capital gains rate. Filing an extension may be a consideration, talk with a CPA for
advice. Needing to sell and move for specific reasons may have cause for exclusion of
gains tax prior to two year ownership.
Save Receipts
Always save receipts for home improvements in a "house file". If you don't
qualify for the 2 year ownership rule, the cost of improvements can be used to offset
capital gains tax you may have after the sale of your property.
People Benefited Now
- Wanting to downsize, children have all moved out.
- Retirement and move out of the area to less expensive area.
- Job relocation from area with high property values to lower values.
One Thought
People with rental property could sell their current home, move into their rental for two
years and sell it under the $500,000/$250,000 provision with the same benefits.
Change in Property Values?
It is unknown how many people have been waiting to sell their property until this bill was
passed. One possible scenario: Many homes are suddenly put on the market.
The Immediate Impact
Should not immediately affect property values as there currently appears to be more buyers
than sellers. Immediate effect would be properties with more "days on the
market". This would hurt sellers needing to move soon or those sellers who listed the
house over market value.
The Next Impact
When more and more houses are put on the market with fewer buyers this market peak will
end. Property values could go back down again like 7 years ago, to start a new cycle.
Timing for those sellers sitting on the fence could mean more money made. Contact your
accountant or tax attorney for advice.
Penalty-free IRA
The final package allows penalty-free early withdrawals of up to $10,000 from an IRA to
help with the down payment on a first-time home purchase. The IRA can be the home
purchaser's own account or can be a parent's or grandparent's.
Need Answers
If you are not sure what tax consequence you face when selling real estate, consult with a
CPA or tax attorney and not a real estate agent.
Types of Property
Ownership
Should you own your
Florida home in your own name or is there a better way? We are often asked the above question. While we can not give
legal advice we have seen an increasing trend to some type of corporate ownership. The
article below may give you some additional insight.
Why LLCs ?
CAN EVERY LANDLORD BENEFIT FROM USING AN LLC ?
The Limited Liability Company (LLC) is possibly the best asset protection tool available
to Landlords today. It is the second most popular after the Revocable Living Trust. The
LLC provides greater asset protection than using most Land Trusts, better control over
your assets than using Irrevocable Trusts, and more complete asset protection than using a
Limited Partnership or Family Limited Partnership. The LLC does not have the same
limitations as the S-Corporation and can have more favorable tax treatment than the S
Corp.
What is an LLC?
A Limited Liability Company is a general partnership and a corporation
merged together. It is chartered like a corporation with articles of organization and a
certificate of charter from the State Corporation Commission. However, its organizational
documents that are signed after the charter is received are more like a general
partnership agreement with "members" instead of partners. The "operating
agreement" governs the activities of the members and will appoint one or more
managing members to act on behalf of the LLC like a board of directors authorizes officers
to act on behalf of a corporation. The LLC then functions more like a partnership than a
corporation from that point on, skipping the board meeting minutes and corporate
resolutions and three-step management so common in corporations. Single member LLCs are
common, with the sole owner acting as managing member.
How should I set up my LLC?
Once you organize your LLC, you will want to place all of your rental properties in the
LLC. This will protect your personal assets from liabilities created by virtue of your
ownership of the rental properties. The LLC creates a "fire wall" around your
rental properties which keeps any legal "fires" inside the LLC so they cannot
get out and burn up your personal assets as well. The LLC, therefore, protects the assets
you hold outside the LLC from the assets you put inside the LLC.
What should I name my LLC?
Many would like to name their LLC after themselves. However, part of a good asset
protection plan involves keeping things quiet. Privacy is important. You don't want to
walk around with a target on your back. If it is difficult to find out who the true owner
of an LLC is, it is more likely you won't be targeted in a lawsuit against your LLC. Pick
a name that is not easily identified with you or your family. Many of my clients will
accomplish privacy, while at the same time use a name that honors a
deceased family member or friend, or a favorite pet.
Should I use more than one LLC?
You can use more than one LLC to further protect your assets. With each additional LLC you
use, you are creating additional fire walls to protect rental properties from liabilities
arising from other rental properties. So, the first LLC you create, should
hold all of your rental properties so your home, your retirement, your savings, and your
stocks and bonds are protected from all of your rental ownership liabilities. The second
LLC you create should hold your more risky rentals so you protect your safer
properties from the liabilities of the riskier properties. As you use additional LLCs, you
should group your properties according to risk, until, if you desire, you end up with one
LLC per property.
Can I have too many LLCs?
The practical side of owning one LLC per property is that it can become expensive and
burdensome, especially for those who own more than five properties. Legally, the ideal
asset protection plan would involve one LLC per property. But, most landlords with more
than five properties will want to use two to five LLCs and then group their properties
according to risk in order to minimize the chances of losing too much when a liability
arises than insurance won't cover. Each LLC requires an annual fee to the State
Corporation Commission and a separate tax return each year. Each LLC needs to have
financial records for tax purposes. For some landlords, one LLC is enough, but others
won't feel comfortable unless each property is in it's own LLC. It comes down to a matter
of risk tolerance verses the cost of the protection.
What about protecting my properties inside my LLC?
The best way to protect your properties inside your LLC is the same way small businesses
have been protecting shareholders of closely-held corporations for decades: keep little
value inside the entity. It is not hard to run a corporation, where most of its hard
assets are leased, and if it was sued for a considerable amount, it could be shut down
without the shareholders losing much. Then the shareholders organize a new corporation,
free of the lawsuit, and keep running the same business out of the new corporation. With
rental property it is a bit different, because it is the ownership of the property itself
that can create the greatest liability. You cannot lease your rental property to your LLC
to accomplish protection of that asset. No matter how you set it up, there will be an
owner and the owner will be subject to potential lawsuits based upon ownership. The only
way to protect the properties inside the LLC from being taken from you, therefore, is to
decrease the value of the asset itself by mortgaging the property. If you have one rental
property inside your LLC worth $100,000 and you have no mortgage on the
property, you stand to lose up to $100,000. If the same property inside your LLC has a
$90,000 mortgage on it, you stand to only lose up to $10,000. If you choose to thus
"strip" the equity from your property to devalue it for asset protection
purposes, you can either use a commercial lender and take the cash out to invest it in
stocks and bonds, pay off personal debt, purchase more rental properties, or utilize it
any other way you choose, or you can use a private lender, including a
controlled entity and hold the paper yourself. Either way, you have taken most of the
value out of the LLC, and protected it from liabilities that arise inside the LLC.
Ideally, you will strip all of the value from the properties inside your LLC so that you
lose no value if your insurance doesn't cover the liability. You will not lose the
property itself either, because it has no value, the judgment creditor will abandon it.
Even if it is producing rental income, the income has to go to the mortgage holder(s)
first, before it can go to a judgment holder. If the judgment holder is content to place a
judgment lien on the property and wait till the rents pay down the mortgage(s) and create
equity, foreclosure on the mortgages can erase the judgment lien. Complete asset
protection is possible to achieve. Why settle for anything less?
If you can use an LLC to protect all of your personal assets from all liabilities created
by rental property ownership, and you can also protect all of your rental properties
inside the LLC from ever being taken away from you, them maybe the LLC is for you.
Warning: This article is not a legal opinion.
Each and every circumstance is different. Consult competent, independent legal advice
prior to taking any action based upon the information in this article.
