Foreign Investments in U.S. Real Estate Property: Income Types and Tax Deductions

March 3rd, 2021

Universal Commercial Capital is private money loan broker dedicated on offering financial consulting and solutions to its international real estate costumers. Within the below article we aim to create basic understanding on US income tax rules for entrepreneurs who are nonresidents and further outline what tax deductions need to be considered by the foreign real estate investors.

Firstly, it is important to know that nonresident investors are taxed on the following two types of income:

1 Effectively Connected Income (ECI) Taxes need to be paid on the net received from a business or trade with the United States. Internal Revenue Service (IRS) considers there is a “trade or business carried in the Unites States” when a given activity is profit driven and the venture is carried regularly, continuously and substantially. If the foreign investor is generating net income from ECI, the investor is obliged to pay income taxes, yet certain credits and deductions are allowed.

2 Fixed or Determinable Annual or Periodic (FDAP) Income that is received in the USA is treated differently than the effectively connected income described above. As FDAP income IRS considers payments received in the form: interest, annuities, rent, dividends, compensations, wages, premiums, remunerations. The FDAR income is taxed at 30% flat rate and deductions are not permitted, however, if the beneficial owner is a resident of a treaty party country, certain tax reductions may apply. For instance, income tax on dividends may be reduced, but for income generated from U.S real estate property reductions are usually not allowed.

Under Section 871 (d) IRS allows individual nonresident taxpayers to file an election where the generated income from US real estate property is treated as ECI instead of FDAP. Making the election will grant the taxpayer with the right to claim deductions attributable to the real property income. Additionally, the net income from real property is taxed at graduated rates. The election can be made solely for real estate properties that are producing income; those with expenses higher than the income are not eligible. The tax return has to be filed in time and the election remains in effect for all future years. Yet, certain FDAP income is excluded from the election. Corporations can use Sect. 882 (d) to elect the ECI taxation.

To claim the election IRS will ask for a statement with a complete list of the investment real estate properties in the USA and their particular location, the dates the subject properties were acquired, income generated from the properties, a description of any major construction works/ improvements to the property, the extent of ownership in the property. Additionally, if election is made the foreign investor who is a beneficial owner of U.S. source income must send Form W-8 ECI to the withholding agent or payer.

Last, but not least, the Foreign Investment in Real Property Tax Act (FIRPTA) rules that when a foreigner sells a US investment property, the involved transferee must deduct and withhold a tax on the total amount realized by the foreign person on the disposition. The rate of withholding generally is 15%.

If you are a foreign investor looking for a reliable overseas financial partner, please contact Universal Commercial Capital.