Recently, the Financial Crimes Enforcement Network (“FinCEN”) promulgated new rules which require certain U.S. title insurance companies to identify the natural persons behind companies used to pay “all cash” for high-end residential real estate in Miami-Dade County, Florida.
According to the 2015 Profile of International Home Buyers in the Miami Association of Realtor Business Areas, foreign real estate buyers account for 36% or $6.1 billion of total sales volume in the South Florida real estate market. Florida remains the top state for international buyers accounting for 21% of all foreign purchases in the United States. Miami in particular continues to have the most foreign buyers accounting for 74%, which is more than double than the national figure of 35%.
As a result, it is more important than ever for realtors with foreign buyer clients to have their clients engage an international tax attorney to ensure that the ownership of the property is structured with tax efficiency. Foreign persons purchasing U.S. real estate without consulting an international tax attorney may be putting themselves in precarious tax positions if the tax implications are not considered. Below is a high level discussion of some of the key issues.
Estate Tax Considerations
Generally, a foreign person is subject to U.S. estate tax on the ownership of all U.S. property. IRC §2103. While U.S. citizens have a 2016 U.S. estate tax exemption of $5.45 million per person, which renders the U.S. estate tax inapplicable to most U.S. citizens, foreign persons, not domiciled in the U.S., have only a $60,000.00 U.S. estate tax exemption, meaning virtually every foreign person not domiciled in the U.S. must be concerned with the U.S. estate tax. The tax rate for U.S. estate tax is 40%. Therefore, without proper structuring, a foreign person who dies while owning U.S. property, will need to pay tax on 40% of the total value of the U.S. property.
Perhaps the common misconception is to have foreign clients purchase the property through a single member U.S. LLC or a U.S. corporation. This will not protect a foreign person from being subject to U.S. estate tax. Moreover, without consulting tax counsel in the foreign person’s home jurisdiction, purchases of U.S. real estate through different types of companies and/or trusts could cause negative tax consequences in the foreign person’s home jurisdiction.
Income Tax Considerations
Foreign persons are subject to U.S. income taxation only with respect to certain income which is determined to be U.S. source income. An evaluation of the types and source of income is essential to all foreign persons here in the U.S.
Effectively Connected Income (“ECI”)
Income effectively connected with the conduct of a U.S. trade or business (“ECI”) is subject to U.S. income tax at regular U.S. income tax rates on a net basis, as determined after subtracting expenses such as depreciation, mortgage interest, and property taxes from the subject income. Whether income is ECI is determined on a case-by-case basis, examining the totality of the facts and circumstances. Rev. Rul. 88-3, 1988-1 C.B. 268.
Fixed Determinable Annual or Periodic (“FDAP”)
If a foreign person is not receiving ECI, then the foreign person is subject to 30% withholding tax on all fixed, determinable, annual, or periodic (“FDAP”) U.S. source income. IRC §§871(a)(1)(A) and 881(a)(1). Common types of FDAP income are interest, dividends, rents, salaries, and wages. The detriment to this tax is that it is taxed on a gross basis, meaning you do not get to net your expenses against your income. IRC §§1441 and 1442.
Foreign Investment in Real Property Tax Act (“FIRPTA”)
FIRPTA requires that a foreign person’s gain on the sale of U.S. real property is taxed as ECI. IRC §897(a)(1). The gain is subject to U.S. capital gains rates, unless owned by a corporation. Real estate closings on or after February 17, 2016, will be subject to the new FIRPTA withholding rate, which is increasing from 10% to 15%. Therefore, when a foreign person disposes of U.S. real property, 15% of the purchase price must be withheld by the buyer, regardless of the amount of the foreign person’s gain. IRC §1445(a). However, it is important to note that Form 8288-B can be filed to reduce or eliminate FIRPTA withholding, (1) if the seller is entitled to nonrecognition treatment or is exempt from tax; or (2) if the seller can show that the withholding amount exceeds the seller’s maximum tax liability.
There are a multitude of issues that must be examined when a foreign person is looking to buy or sell U.S. real property. To learn more about the different tax considerations for foreign persons who are purchasing U.S. real estate, please contact the attorneys at Chepenik Trushin LLP, who are ready, willing, and able to assist you with all of your international tax planning needs.