U.S. TAXATION OF REAL ESTATE FOR FOREIGN INVESTORS – U.S. TAXATION OF REAL ESTATE FOR FOREIGN INVESTORS
U.S. Taxation of Real Estate for Foreign Investors
Dear Clients and Friends,
Foreign investors are attracted to U.S. real estate because it has many advantages including income potential, appreciation, and future gains upon sale. However the U.S. tax laws and regulations impose very complex rules and requirements on foreign investors and their agents, including withholding, reporting, and special taxes upon the sale of U.S. real estate. We have prepared this material to explain which transactions are subject to taxation, and the responsibility of the foreign investor and his agents. We are also available for in-house training on this subject at no cost. If interested or have any questions please contact Luana Mendoza at firstname.lastname@example.org.
Taxation under FIRPTA
Generally a sale or exchange of U.S. real estate is subject to taxation under the Foreign Investment Real Property Tax Act (known as FIRPTA) if the investor is a nonresident alien and the property can be classified as either:
1. U.S. real property,
2. U.S. real property interest (USRPI) or
3. U.S. real property holding company (USRPHC)
For purposes of FIRPTA, real property includes three categories of property; (1) land and (2) unsevered natural products of the land, (3) improvements, and personal property associated with the use of real property.
U.S. Real Property Interest (USRPI)
Under the FIRPTA rules, U.S. Real Property Interest (USRPI) is defined as:
An interest, other than solely as creditor, in real property located in the U.S. or the Virgin Islands,
An interest, other than solely as creditor in a domestic corporation, unless the taxpayer establishes that the corporation has not been a U.S. real property holding corporation for generally five years prior to the disposition of the interest, or
An interest in a partnership in which 50% or more in value of the gross assets consist of USRPI’s, and 90% or more of the value of the gross assets consist of USRPI’s and cash or cash equivalents.
An interest solely as a creditor in real property or domestic corporation is not a USRPI. Therefore, the disposition of an interest solely as a creditor is not subject to taxation under FIRPTA.
U.S. Real Property Holding Corporation (USRPHC)
For purposes of FIRPTA, a foreign or domestic corporation is an USRPHC if the fair market value of its USRPI’s on any of the applicable determination dates is at least 50% of the sum of the fair market value of:
Its total USRPI’s.
Its total interest in real property located outside the U.S.
Any other assets used, or held for use, in a trade or business.
Interest in a Foreign Corporation
Solely for the purpose of determining whether a corporation is a USRPHC, an interest in a foreign corporation is treated as a USRPI unless the foreign corporation was not a USRPHC at any time. This means that if a domestic corporation owns a foreign corporation, and that foreign corporation is a USRPHC, the interest in the foreign corporation will be a USRPI for the purpose of the asset test for the domestic corporation. However, any direct interest in a foreign corporation – even if its holds all USRPIs – will not be treated as a USRPI for purposes of taxing the gain.
Therefore, if a foreign person owns 100% of a foreign corporation and that foreign corporation only owns U.S. real estate, the gain on the sale of the stock of the foreign corporation will not be subject to the FIRPTA tax. However, there is a limited exemption, because when the U.S. real estate is disposed of it will trigger a FIRPTA gain either through a direct sale or other type of disposition, like a liquidation of the foreign corporation.
Dispositions and Distributions
Generally, FIRPTA imposes taxation and withholdings upon the disposition of a USRPI or stock in a USRPHC, whether that disposition takes the form of a sale, exchange, a liquidation of a corporate interest, redemption of stock, and/or a distribution of a USRPI.
Withholding on FIRPTA
The withholding rules under FIRPTA are very complex and impose a withholding obligation on the buyer and his/her agents. The following are the primary considerations:
The amount to withhold on the sale by a foreign investor of a USRPI is normally 10% of the amount realized (gross sales price).
The withholding obligation is imposed on the buyer and his agents.
A buyer must report and pay any tax withheld within 20 days after the date on which the transfer of a USRPI occurs.
The IRS can reduce withholding under certain circumstances.
A buyer will have a withholding obligation only if the seller is a foreign person and the buyer is acquiring a USRPI or USRPHC.
A foreign investor in U.S. real estate must carefully plan and structure their investments to minimize the impact of the FIRPTA rules. A properly structured investment can avoid many of the unpleasant surprises when a sale of U.S. real estate is made by a foreign investor.
We have over 25 years experience in the international tax area and would be glad to assist in your real estate transactions. Please call us for further information.
This information is a presentation of the general rules and should not be used or relied upon for any particular investment or transaction. We recommend you consult your tax attorney or advisor for your specific situation. If you would like more information on these matters we would be glad to visit with you.
As required by United States Treasury Regulations, you should be aware that this communication is not intended or written by the sender to be used, and it cannot be used, by any recipient for the purpose of avoiding penalties that may be imposed on the recipient under United States federal tax laws.