Copyright 1996, Marc S. Weissman
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Certified by the California Board of Legal Specialization of The State Bar of California
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U.S. TAX CONSEQUENCES OF FOREIGN INVESTMENT IN U.S. REAL ESTATE

This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

When a foreign person invests in U.S. real estate, the taxation rules are different than those for U.S. persons.

FIRPTA

See FIRPTA, updated 1/00

GENERAL INCOME TAX RULES

U.S. citizens and U.S. residents are taxable on worldwide income. Thus, an American (citizen or resident) with overseas income may face double taxation for property held overseas. In most cases there is a credit for such double taxation, dependent upon the tax rates and Tax Treaties which might apply.

Non-resident aliens are taxable only on U.S. source assets.

A U.S. resident for income tax purposes, is any person who has a green card or who meets the "substantial presence test" (180 days in the U.S. during any 12 month period, or an alternative test which requires more than 4 months presence in the U.S.). [A different definition for estate taxes is described below; a person may be a U.S. resident for income tax purpose and not for estate tax purposes, or vice versa.]

U.S. source income is income from U.S. domestic corporations, banks, real estate, or other U.S. activities including a trade or business connected to the U.S.

Foreign corporations are not U.S. source assets even if the corporation is doing business in the U.S. or owns real estate in the U.S.

However, use of the foreign corporation will not save any income taxes because income tax rates for foreign corporations or foreign individuals are the same: 30%.

[U.S. corporations pay lower tax, if any.]

Special Income Tax Rules.

Section 1031 ("Starkers" or Tax Deferred Exchanges) treatment is available to an NRA.

Other than real estate, in general, capital gains are not taxable to non-residents aliens.

Most interest is tax free, unless effectively connected with the active conduct with a U.S. trade or business.

A 30% tax rate applies to both foreign individuals and corporations.

ESTATE TAX RULES

A different definition for estate tax residency is in the Internal Revenue Code. For estate tax, a resident is any person who intends to reside in the U.S. and is actually present in the U.S., regardless of his legal status or residency under the income tax rules.

A non-resident alien may leave only $60,000 tax free: U.S. residents are allowed to leave $600,000 tax free.

Spousal gifts (which are tax free to U.S. citizens spouse) are not tax free to any non- citizen unless made pursuant to a qualified domestic trust (QDOT).

Only U.S. charities qualify for deductions from estate taxation.

The lesson from all of this information is that long term U.S. real estate investment should be made through a foreign corporation, which owns a U.S. corporation, which owns U.S. real estate and other assets. This type of structure minimizes income taxes and legitimately avoids all U.S. estate taxes; at the owner's death, assets then pass tax free to his heirs.

The NRA owns stock in a foreign corporation. That is not a US asset. Even if the foreign corporation owns US real estate, no death taxes are imposed. To avoid the Branch Profits Tax, a foreign corporation should not own US real estate. Therefore, the NRA owns foreign corporate stock; the foreign corporation owns a US corporation; freedom from US death taxes is achieved.

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