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Tax Planning for Foreign Investors in US Real Estate

Learn essential tax planning strategies for non-US residents investing in US real estate to maximize benefits and avoid pitfalls. Explore structuring options, fiscal cliff impact, FIRPTA rules, transaction costs, and case studies. Always consult tax advisors for specific situations.

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Tax Planning for Foreign Investors in US Real Estate

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  1. Tax Planning for ForeignInvestors in US Real Estate Robert J. Kiggins, Esq. McCarthy Fingar LLP ITSAPT Conference November 8, 2012 rkiggins@mccarthyfingar.com

  2. Disclaimer • My views and notions of relevant law are being presented not those of McCarthy Fingar LLP • This presentation is for informational purposes only and is not intended as tax or legal advice • Always seek counsel for any specific tax or legal situation.

  3. Why the USA? • Prices are relatively low – bargains??? • Interest Rates are Attractive • But tax planning is essential

  4. What is a Non-US Resident • Income Tax • Individual • Not a US Citizen • Not a US Permanent Resident (No “Green” Card”) • Not present in the for “too long” - 183 day weighted counting test over 3 year lookback period triggered by current year presence of over 31 days. • Entity – Not chartered in the US (50 states, federal, and territories and possessions) • Transfer Tax (Estate and Gift) • Individual – domicile test – home is where the heart is • Entities – N/A

  5. One Size Does Not Fit All • Since every transaction is different, no single solution fits every case • Structure appropriate for a non USA resident family with an aging patriarch who wants to invest $95 million dollars in active rental and developmental properties vacant land is probably unacceptable for the 35 year old son of the family who wants to buy a Manhattan condo to live in while on assignment in the US for five years • We’ll discuss that more when I get to the case study.

  6. Effect of The Fiscal Cliff • The classic US tax trade off was/is using corporate holding structures to avoid estate tax (35% top rates) at the expense of higher income (35% top rates for corporate vs. 15% for capital gains for individuals) • This equation may change to tilt the preference to corporate structures in 2013 with estate taxes slated to go up to 55% top rates, corporate rates perhaps to come down (e.g. to maybe 25-28%) and capital gains rates to go up to 20%.

  7. A Note on LLC’s • These are very “hot” in the US • However, they don’t tend to mix too well with tax treaties • Hence, generally to be avoided in the context of holding structures for foreigners investing in US real estate

  8. Non-US Effects Must Always be Taken into Account • US Real Estate investments for foreigners cannot be handled in a US vacuum • It is essential to work with local tax advisers in the home country to make sure that minimizing US tax does not have an untoward consequence in the home country that may more than offset the “savings” in the US.

  9. Don’t Forget Transaction Costs • In the US lawyers (who can be pricey) not notaries handle the legal end of real estate – On the other hand a lot of US real estate lawyers are looking for work so it is a “buyer’s market” for the clients!! • State and local government non-income tax expenses can be very high – More on this in a bit

  10. A Word on FIRPTA • This is a big exception to the rule that non_US residents are not generally subject to US income tax on capital gains from US Sources • FIRPTA treats all sales by non-US residents as subject to mandatory 10% withholding on the gross proceeds of the sale • However, this is not the actual tax which is only on the gain so a refund can and should be applied for where applicable. • The tax is imposed at the applicable graduated US rates • So a US return must be filed in addition to just having the withholding done.

  11. Case Study – The Schiller Group • A wealthy Central Eurozone family. • So let's hedge $95 MM of their € with a US real estate portfolio which they will be 50-50 partners with a US realty group based in NYC. • Also let's give them a 35 year old single son who is going to live in the US for a couple of years to get the US biz going soundly. • Naturally we want him to live in a condo on Park Avenue which he or the family will own at a purchase price of $5 MM. • We’ll start with the commercial holdings.

  12. The Commercial Portfolio • We are going to have our Schiller Group invest in active real estate ownership of income producing and property development (e.g. improvements and construction) • The general rule is to set up a separate holding company for each piece of property • Big step is to consult with home country counsel. We are assuming no home country tax problems for the sake of this discussion.

  13. The Commercial Portfolio • Generally, advisable to partner with an experienced US operator. • We generally see a three layer structure • A Foreign Company • Owning a US Company (here US companies) • US Companies own the real estate

  14. Reasons for the Structure • Foreign Co – Avoids US Estate Tax – At what may well turn into 55% rates next year • US Co - This Avoids a 30% Branch Profits Tax which is imposed on top of the 35% (maybe 25 to 30%) Regular US Tax Rate • The more than 80% common ownership of each separate company will allow the filing of tax returns on a consolidated basis – so income of one project can be offset by expenses of another

  15. Funding - Debt or Equity • It is generally more tax efficient for US tax to use debt rather than equity • Interest on debt is deductible against income • Interest payments to the foreign holding company are often subject to favorable treaty withholding rates – e.g. the rate is nil under the US Germany tax treaty • Note: Local counsel in the home country would have to be consulted on tax effect in home country

  16. Beware Earnings Stripping Rules • To avoid treatment as dividend the ratio of debt to capital cannot exceed 3:2 • If it does there will be no deduction allowed for interest • AND the entire payment amount not just the interest element will be subject to withholding – e.g. 50% German owner would have 15% US withholding

  17. The Tax Downside • Gains will be taxed at 35% (maybe 25% to 29% under Obama Romney proposals) • Outright ownership would have taxed gain at 15% (maybe 20% under fiscal cliff)

  18. Downside Solution – 1031 Exchange • Gains can be deferred by swapping into other higher priced “like kind” property • This device too can be used to sell shares of the foreign company free of US tax at a higher price on account of the ability of a US buyer to defer recognition of the gain through a 1031 exchange

  19. General Design for the Son • We would likely look at having him own the condo outright. Let’s say this condo costs $5 million • If the property appreciates after his stay here and is sold at a gain then the tax rate is 15% on the gain (perhaps 20%) • The exposure is estate tax (at perhaps 55% rates) if he dies while living in the US but since he is young and healthy with no dangerous hobbies this is not likely. • A 5 year term life policy for a 35 year old male in excellent health for say $2.5 million would cost perhaps $1,250 per year. • C.F. If we planned to avoid estate tax (he will likely not be a US resident for estate tax purposes) with say a foreign corporate ownership we would add FIRPTA complications (10% withholding on sale) plus tax at perhaps 25-35% on the gain • N.B. We are absolutely assuming away any home country tax issues that this transaction raises.

  20. Costs of Buying and Selling New York State and City Condo • These costs typically are: • A “Mansion” Tax of 1% of the total contract price if the price is $1,000,000 or above. • New York State Real Estate Transfer Tax of $4 per thousand (.4%) • New York City Real Property Transfer Tax of 1% on transfers less than or equal to $500,000, or New York City Real Property Transfer Tax of 1.425% on transfers over $500,000. • Mortgage Recording Tax (if the buyer is obtaining a mortgage loan): • Under $500,000: 2.05%, of which .25% is paid by the lender. • Equal to or greater than $500,000: 2.175% of which .25% is paid by the lender.

  21. Purchasing the Condo – Putting Numbers to the Costs • The following is an example of the costs of purchasing a New York City condominium apartment from a sponsor. Assume a $5,000,000 purchase price and a $2,500,000 mortgage. • The Schiller son will pay, in addition to the contract price, approximately $204,9823 consisting of the following: • “Mansion Tax”: $50,912 (payable by all buyers) • New York City Real Property Transfer Tax: $72,550 • New York State Real Estate Transfer Tax: $20,365 • Mortgage recording tax: $46,875 • Title insurance: $14,280 • The Schiller son may also be required to pay a contribution to a working capital fund equal to one or two month’s common charges and the sponsor’s attorney’s fees for attending the closing.

  22. THANK YOU! Robert J. Kiggins Counselor-At-Law McCarthy Fingar LLP 11 Martine Avenue White Plains, NY 10606 Tel (914) 946-3700 Ext. 324 E-mail: rkiggins@mfdds.com

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