There are plenty of opportunities for foreigners investing in the U.S. real estate market and real estate professionals, sellers and brokers are working with them for that purpose. A foreigner acquiring real estate property for part time residence or as a rental investment, the tax law could be confusing especially the variations that occur state by state in the United States of America. As there are benefits of investing in real estate properties and considering the hefty profit margins, there are also strict rules and regulations to go through for the same procedure. American tax rules which apply to ownership and dispositions of U.S. real estate by foreigners vary in some important factors as opposed to the same applicable to local U.S. residents. There are also special rules for property managers managing the real estate property for the foreign owners. It is recommended that a foreigner investing in U.S. real estate properties retain a U.S. law and accounting firm to structure their entity and file any necessary tax returns.
When it comes to holding a real estate property, there are 3 basic rules for a foreigner to follow:
* Limited Liability Company (LLC)
* Limited Partnership (LP)
Out of these three, LLC is the preferred and most followed route for potential savings on taxes and even additional tax returns. But due to the complex taxations issues it can be hazardous if one is not careful. For e.g. If a Canadian citizen use LLC to hold U.S. real estate property, it can be costly due to double or even triple taxation issues. For any foreign investor, S-Corporation is not a viable option and cannot be owned by a foreigner. Such is the legal structuring for foreign investors.
There is also another issue such withholding tax, especially the IRS (U.S. Government) wants to make sure that certain withhold taxes from rent or sale of the property to ensure that the U.S. gets its tax and doesn’t get in a tight corner. Withholding agents can simple be a realtor, title company or seller of the property.
* Property sale – This particular withholding rule has its own set of guidelines and the foreign investment in real property tax act (FIRPTA) requires a FIRPTA withholding tax of around 10% of the amount realised on the disposition of all U.S. real estate property interests by a foreigner. A foreign buyer of U.S. real estate property interest from a foreign investor is considered the transferee as well as the withholding agent. A transferee must find out if the transferor is a foreigner because if the transferor is a foreigner and the transferee fails to withhold, the buyer may be held liable for the tax. Seller must report that sale of the real estate property interests by filing a U.S. Federal Tax Form 1040-NR or Form 1120-F
* Passive investment – In terms for passive investment, a passive activity would be considered a typical rental property and not a net lease as in which the lessee pays rent as well as all the taxes, operational expenses, repairs and interest in principal on existing mortgages and insurance in connection with the property. Such a passive rental income is subjected to a flat 30% withholding tax unless it is reduced by an applicable income tax treaty, that withholding tax applied to gross income rather than the net rent received. Gross income and withheld taxes must be reported on Form 1042-S, Foreign persons U.S. source income subject to withholding to the IRS and the payee by March 13 of the following calendar year. The payee must also submit Form 1042, annual withholding tax return for U.S. source income of foreign persons by March 15.
Foreigners may also wish to be treated as a foreigner engaged in a U.S. trade or business. A foreign investor is considered to be engaged in a U.S. trade or business such as the developing, managing and operating a major shopping centre. In that case the rental income will not be subject to withholding and will be taxed at ordinary progressive rates. Also the expenses such as mortgage interest, real estate property taxes, maintenance, repairs and depreciation may then be deducted in determining net taxable income. The nonresident must make the estimated tax payments for the tax due on the net rental income. However if an income tax return Form 1040NR for nonresident foreign individuals and Form 1120-F for foreign corporations is timely filed by the foreign investor, these expenses can be deducted.
For a foreign buyer, their real estate agents who are selling to, buying from or managing real estate property for them must know how to properly deal with foreign investors in U.S. real estate market in order to be in compliance with the federal tax laws affecting the real estate transactions. This is where our experienced agents come into aid a foreign buyer. For more info including how annual income tax returns work for foreigners, email or contact us.