The U.S. is a stable and secure place to invest in real estate. U.S. real property is generally characterized by steady appreciation and less volatility than financial markets. This makes U.S. real estate an attractive investment for many foreigners. This article addresses the basic concepts surrounding U.S. jurisdiction over foreign investors for U.S. income, gift, and estate tax purposes, as well as potential legal complications foreign investors face in the U.S.
Who Is Considered A “Foreigner” Or An “Nra”
For income tax purposes, Section 7701(b) of the Internal Revenue Code defines foreigners and non-resident aliens (NRAs) as individuals who are neither U.S. Citizens, green card holders, nor U.S. tax residents. Unless an NRA possesses a green card, the test to determine if an NRA qualifies for the same status as a U.S. citizen or resident individual is based on “substantial presence.” An NRA is usually considered to have had a “substantial presence” in the United States for a particular calendar year if the NRA is both physically present in the U.S. for at least 31 days, and, in that same calendar year, is considered to have been in the U.S. for a combined total of one hundred and 183 days or more over the past three years pursuant to a complicated look back formula.
For gift and estate purposes, NRAs are individuals who are not domiciled in the U.S. at the time of making the gift for gift tax purposes, or at the time of death for estate tax purposes. The test to determine domicile is subjectively based on one’s intent of permanency in a particular country. Therefore, an NRA is considered a U.S. “estate and gift tax resident” if the U.S. is found to be the permanent home where the individual ultimately intends to return. In such case, the U.S. estate tax would apply to their worldwide estate consistent with the treatment of a U.S. resident. Importantly, NRAs are nevertheless subject to estate and gift taxes on any assets actually situated in the U.S.
Pitfalls: What May Seem “Foreign” To The Foreign Investor
Foreign investors should be aware of the customs and practices that surround purchasing real estate in the U.S. For example, in Manhattan approximately 75 percent of the residential property is cooperative property. Thus, a foreigner must accept the concept of owning shares of stock in a corporation rather than real property. Additionally, cooperatives are free to reject sales and rentals of units based on the cooperative board’s review of the purchaser’s financial and personal application (although cooperative boards may not discriminate against a purchaser based on certain protected categories including race, color, religion, etc.). The cooperative form of ownership also bears important tax consequences to the foreigner. While estate tax issues are the same for condominiums and cooperatives, the transfer of cooperative shares is not subject to a gift tax. Succession of ownership is also relevant to understand. For example, a foreigner owning a cooperative unit who dies without a will would be subject to the succession laws of such individual’s home country or domicile. In the case of a condominium, the law of the situs of the property controls for inheritance purposes.
Because there are numerous traps for unsuspecting foreign investors when purchasing U.S. real property, and to meet the needs of each individual, it is important to consider how any purchase is structured. For example, the direct ownership of real property may reduce the rate of income tax paid but cause the individual to be subject to estate taxes, and may cause that individual to lose some of the jurisdictional exceptions that might avoid income tax altogether. Structuring options include conducting the real estate business in the U.S. as an individual owner, as a member of a limited liability company (LLC), or as a shareholder of a domestic or foreign corporation. In making such decisions, foreign investors must consider and weigh the interplay of federal and state income taxes, estate and gift taxes, and any desire for tax anonymity.
Therefore, foreign investors must work with a qualified team of legal, accounting, and brokerage/valuation professionals who as a team understand the interplay of the relevant tax laws of the foreigner’s home country with those of the United States. The goal of the professional team should be to assist the purchaser in facilitating the most efficient investment, accounting, and tax structure in the purchase transaction.