Important Considerations
There are a great many reasons why foreign investors choose to invest in U.S. real estate. The U.S. has a secure, stable economy and political environment, with attractive investment opportunities compared to other countries. In a world of political turmoil, it is a safe and secure place to live or dwell.
1. Direct Ownership
This is the simplest form of ownership. From a tax perspective, the major drawback is that the value of the real estate will be subject to U.S. estate taxes (the current top marginal federal estate tax rate is 40%) and/or state estate taxes[1], any gifts of the real interest during lifetime will be subject to potential gift tax, and the NRA will be obligated to file U.S. income tax returns with respect to the real estate. The advantages of direct ownership include its simplicity—no imputed rent issue for personal use, gain is taxed at the preferable capital gain tax rates and the beneficiary receives a step up in basis at death and the easy repatriation of funds without additional tax. In addition, with a proper election, income is taxed at the U.S. graduated individual income tax rates.
2. Corporate Tiered Structure
Most non-resident aliens invest in U.S. real estate through U.S. corporations that are owned by foreign corporations. The primary reason for this form of ownership is to protect the foreign investor from the imposition of estate taxes on the value of the underlying real estate as discussed in A above[2]. This strategy for real estate ownership comes with an income tax cost. The disadvantages of this structure include higher tax rates[3], imputed rent for personal use, no inside basis step up and increased tax compliance reporting.
3. Irrevocable Foreign Trust
If U.S. real estate is owned by an Irrevocable Foreign Trust, the real estate will not be subject to U.S. estate tax. This strategy for real estate ownership also comes with an income tax costs—additional reporting and loss of control over the underlying real estate. The disadvantages of this structure include the highest income tax rates, imputed rent for personal use, no inside basis step up and increased tax compliance reporting.
In the case of real estate of significant income-producing property, the tiered corporate structure is the most common ownership structure. The cost and complexity and the higher income tax exposure render this approach less cost effective for the NRA with a single or limited modest real estate holdings, especially where the real estate is intended for personal use. In this case, many NRAs opt to purchase a life insurance policy sufficient to pay the estimated estate tax liability.
NRAs may utilize life insurance to address a variety of situations, including:
- Forced heirship rule of their own country;
- Equalizing estate distributions among children;
- Providing a source of funds in the event of a separated spouse;
- Ability to use life insurance cash values for other U.S. investments;
- Gifting of the life insurance policy on the life of an NRA free of any gift tax;
- Providing a benefit for the NRA spouse of a U.S. citizen that is not subject to special and onerous estate tax rules;
An NRA with any U.S. connections, whether investment or personal, should consider life insurance as a part of his or her investment or wealth transfer plan.
If you would like more information on this subject, or have a client who might benefit from a discussion about it, please contact Barry Koslow at bkoslow@mkaplanners.com or (781) 939-6050.
Securities offered through Advisory Group Equity Services, Ltd., Member FINRA/SIPC. 444 Washington Street, Woburn, MA 01801 (781) 933-6100.
This article should not be considered as providing accounting, business, financial, investment, legal, tax, or other professional advice or services. It is not a substitute for such professional advice or services, nor should it be used as the basis for any decisions or actions that may affect your business or you personally. This should only be one part of your research. You should seek authoritative guidance from a qualified accountant or attorney before taking any action.
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[1] For example, if the real estate was purchased for $3, 000,000 and had a value of $5,000,000 at death, the U.S. Federal Estate Tax alone could be as high as $2,000,000 ($5,000,000 x 40%). It is important to note that if the property is secured by a non-recourse mortgage, only the net amount will be includible in the estate.
[2] Ownership through the use of a tiered of structure eliminates the United States estate tax exposure since the stock in the foreign corporation that is owned by the NRA is not subject to U.S. estate tax.
[3] The current maximum capital gains rate for individuals is 20% (for taxpayers in the 39.6% bracket) and a flat 35% rate for corporations. In this case, if the real estate were sold for $5,000,000, the capital gains tax (if the real estate were owned individually) would be $400,000 ($2,000,000 x 20%), and (if owned by a corporation), the capital gains tax would be $700,000 ($2,000,000 x 35%).
