If the foreign buyer does take title in his or her name, the good news is that when he or she decides to sell the property, the gain will be taxed at the long-term capital-gains rate of 15%, assuming the property was held for more than a year. However, when it comes to estate taxes, the foreign buyer who holds the title in his or her name is taking a significant risk because if he or she passes away while owning U.S. real estate, the entire value in excess of $60,000 will be subject to taxes at rates as high as 45%.
For U.S. tax residents, green card holders, and American citizens, it’s a different story. The current standard exemption for U.S. citizens and resident aliens is $2 million. So if the value of their assets is less than $2 million at the time of death, they will not be subject to the U.S. estate tax. Also, the U.S. citizen or green card holder can pass on all assets to his or her spouse estate-tax free.
There are additional risks surrounding foreigners owning rental property. Anyone who owns U.S. real estate that is operating as a rental property is entitled to take tax deductions for depreciation, mortgage interest, property taxes, expenses of management and repairs, etc. The benefit is that income tax is only paid on the net rental income, assuming that there is a profit after the deduction of all of the rental expenses.
Foreign owners of U.S. rental property face a more complex issue. As long as they file their income taxes to report the rental activity (income or loss) in a timely manner, they are entitled to make a special election called a “net election.” This election allows them to report the rental income net of all property-related expenses (interest, taxes, maintenance, depreciation, etc.).
However, if a non-U.S. property owner does not file his or her income taxes in a timely manner, he or she loses the opportunity to make the “net election” and will be subject to a federal income tax of 30% of the gross rent with no deduction for any business expenses. So the foreign owner of U.S. rental real estate who has not been filing tax returns because he or she is losing money and does not see the value or need to file annual income tax returns is in for a rude awakening. Even worse, when he or she sells the real estate, he or she will not be entitled to use any of those prior losses to reduce the gain on the sale since they were not properly reported to the IRS. This is a harsh law, but it is how the IRS enforces tax compliance.
There are many tax issues facing the foreign buyer of U.S. real estate. Yet with proper tax planning and compliance that takes into consideration both income-tax and estate-tax issues, the result can and will be tax efficiency and, ultimately, a greater return on your investment.
About the Author
Alan A. Lips, CPA, is a partner at Florida-based full-service accounting firm Gerson, Preston, Robinson & Company, PA. He can be reached at 305-868-3600 or emailed at aal@gprco-cpa.com.