Investing in another country always a big decision and if it involves buying U.S real estate then the task becomes even more complex. How U.S citizens can buy real estate in the United States is well- documented. However, little information is available about how foreign nationals should invest in U.S real estate. For foreigners investing in the U.S real estate, the U.S tax law can be extremely confusing. Fortunately, this article contains tax tips for foreign nationals investing in U.S real estate. However, before we get to the tax tips for foreign nationals investing in U.S real estate, we need to take a look at a few important things.
The importance of having real estate in their portfolios and the benefits of investing in U.S real estate is something all investors acknowledge. However, the tax laws applicable to U.S citizens buying U.S real estate are somewhat different to the tax laws that apply to foreign nationals investing in U.S real estate. Furthermore, when they are managing property for foreign owners, property managers are subjected to special laws. For all the aforementioned reasons, you’ll find the tax tips for foreign nationals investing in U.S real estate useful. Before we discuss the tax tips for foreign nationals investing in U.S real estate, let’s take a look at some important things.
Investing in U.S real estate
For foreign nationals looking to strengthen, diversify, or stabilize their portfolios, investing in U.S real estate is a sensible thing to do. However, for these transactions, the withholding and income tax requirements imposed by the IRS are complex. You may have to pay additional penalties as well as interest if you don’t follow the investing procedures stated by the IRS. If you’re investing in U.S real estate as a foreign national then getting help from a skilled accountant to manage your affairs would be a sensible thing to do. Apart from getting help from a skilled accountant, there are many more tax tips for foreign nationals investing in U.S real estate. We’re going to discuss all these tips in this article.
Are foreign buyers of U.S real estate subjected to U.S income tax?
U.S tax returns for non-residents are what foreign investors must file on time. Tax at ordinary rates in net rental income are what foreign national investing in U.S real estate will be subjected to. The difference between real estate expenses and gross rent is how net rental income is calculated. Whether or not a foreign national has income tax liability, he or she must file U.S federal and state tax returns on time for each ownership year if he or she wants to tax advantage of the many deductions. This is one of the best tax tips for foreign nationals investing in U.S real estate.
If, as a foreign national, you fail to submit U.S tax returns, you won’t get any deductions and will be taxed based on gross rental income. Let’ suppose, you are a foreign national and earn $50,000 in gross rental income. Now, your rental expenses are $20000. If you file your tax returns then you’ll be taxed on the net rental income of $30,000. On the other hand, if you don’t file your returns, you’ll have to pay tax on $50000 gross rental income. Therefore, filing U.S federal and state tax returns for each ownership year is crucial.
Paying tax when selling U.S real estate
FIRPTA withholding tax and a capital gains tax are what foreign nationals investing in U.S real estate are required to pay. This is one of the tax tips for foreign nationals investing in U.S real estate. For couples earning more than $450,000 and singles earning over $400,000, long-term capital gains rate was increased to twenty percent in 2013. After original purchase price, capital improvements, and closing costs are subtracted from it, gross capital gain is used to calculate capital gains. Furthermore, a foreign national investing in U.S real estate is subjected to a Foreign Investment in Real Property tax (FIRPTA).
FIRPTA requires the buyer to withhold foreign seller tax. Ten percent of the property sale’s gross proceeds are what the FIRPTA withholding tax amounts to. However, you must keep in mind that this tax isn’t an actual U.S tax due. This is one of the most important tax tips for foreign nationals investing in U.S real estate. Ten percent refund of the amount withheld at the sale is what the foreign national will receive if he or she doesn’t have any outstanding U.S tax liability and is current on all U.S tax returns. Capital gain tax and income tax are examples of U.S tax liability. Now that we’ve discussed the relationship FIRPTA and foreign investors, it’s time to look at some more tax tips for foreign nationals investing in U.S real estate.
Are foreign nationals investing in U.S real estate required to pay U.S estate tax?
Many people ask whether or not foreign nationals investing in U.S real estate have to U.S estate tax. The answer to this is yes, foreign nationals investing in U.S real estate have to pay federal estate tax. This is one of the tax tips for foreign national investing in U.S real estate to always keep in mind. Up to $5 million for individuals and $10 million for married couples are the estate tax exemption U.S nationals are eligible to claim. Unfortunately for foreign national, this exemption isn’t available to them. Therefore, to minimize a U.S tax liability, foreign national investing in U.S real estate should check a treaty between the U.S and their country.
Choosing the right structure for holding real estate depends on a number of factors. To make things simple, a foreign national investing in U.S real estate has three options to choose from in regards to holding real estate in the United States. The three options include C-Corporation, Limited Liability Company (LLC), and Limited Partnership (LP). Generally, if you’re looking to save on taxes, LLC is the best route to take. This is one of the best tax tips for foreign nationals investing in U.S real estate. However, an LLC could be a nightmare for you as a foreign national if the U.S has a unique Tax Treaty with your country: this is something I can’t emphasize enough.
For example, as this would result in double or triple taxation problems, you shouldn’t use an LLC to hold U.S investment property if you’re a Canadian citizen.
Also, it is important for you to keep in mind that, as a foreign national, you cannot own an S-Corporation. Therefore, using S-Corporation to hold U.S investment property should not be option for you.
Many foreign nationals investing in U.S real estate choose to be passive investors. Therefore, understanding passive investors and the tax tips for foreign nationals investing in U.S real estate related to them is important. As it means things being simple and withholding less, many people consider being a passive investor a wise decision: Unfortunately, most of the times that isn’t the case. First and foremost, a typical rental property is what a passive activity would be considered as. Furthermore, it will involve a net lease in which the tenant pays rent, operating expenses, taxes, repairs, property relate insurance, and principal interest in existing mortgages.
A flat thirty percent withholding tax applicable to the gross income is what the aforementioned passive rental income is subject to. The net rent received isn’t used here. Therefore, the gross income subject to the thirty percent withholding tax must include the ground rent, insurance premiums paid by the tenant for the foreign national investing in U.S real estate, real estate taxes, principal, and interest on any existing mortgages, repairs, and operating expenses.
Furthermore, as a foreign national, you must report withheld taxes and gross income on Form 1042-S, Foreign Persons U.S. Source Income Subject to Withholding to the IRS and the payee by March 15th of the following year. Also, by March 15, the person paying must submit form 1042, Annual Withholding Tax Return for U.S Source Income of Foreign persons. This is one of the most important tax tips for foreign nationals investing in U.S real estate.
Tax responsibilities of foreign nationals investing in U.S real estate
One of the most important tax tips for foreign nationals investing in U.S real estate involves the tax responsibilities of foreign nationals holding U.S investment property. Regardless of your personal tax status, you’ll be required by the IRS to pay taxes on income received from the property if you own and rent our real estate in the U.S. The income treaty that exists between your country and the United States won’t matter here. Extensive filing documents such as Form 1042-S is required in the U.S for you to file taxes based on income you receive from renting U.S real estate.
As previously mentioned, a thirty percent withholding requirement is what gross U.S rental property income is subject to. However, by properly electing and applying tax treaty provisions, you can substantially reduce this. This clearly shows that by following tax tips for foreign nationals investing in U.S real estate in mind, foreign nationals investing in U.S real estate can significantly reduce the taxes they need to pay. Some great tax tips for foreign nationals investing in U.S real estate are what we’re going to look at next.
Tips for purchasing vacant land
Since it does not usually result in monthly expenses and income, buying vacant land may seem as the easiest U.S real estate investment.
However, the truth is that the foreign investor will not gain any yearly US tax benefit from the payment of real estate taxes, interest expense, and other carrying costs. As a foreign national, if you buy the vacant land for growth and want to capitalize your carrying costs then you must file a tax return to claim an annual election. By doing this, you’ll have something to use against an ensuing capital gain. If you don’t file a tax return no tax benefit will be gained from these costs.
You can construct a personal residence or rental property on the vacant land. You may be considered as a dealer in case the vacant land has to be partitioned. In such a case, you may not quality for lower tax rates or capital gain treatment on sale. If you’re looking for tax tips for foreign nationals investing in U.S real estate then here’s a great tip for you: If you want to plan the tax repercussions of your actions then it’s crucial for you to know how you intend to use the vacant land.
Tax benefits of vacation home and personal residence
A place where you live on permanent basis is referred to as a personal residence. If the property isn’t considered their primary residence, foreign nationals may not qualify for the special tax treatment. If you have a vacation rental, you may consider it as a home during the year if you use it for personal purposes for more than two weeks or ten percent of the total days you’ve rented it out to there at a fair price.
There are many reasons to have a real estate considered as a vacation home or residence. The main reason is that, by proclaiming your real estate as a vacation home or residence, you can get the first $300,000 written off from the ten percent withholding tax when you sell the real estate property. Gain on sale is calculated by subtracting the cost of the purchase, sales expenses, and capital improvements from the sales price. Up to $500,000 if married or $250,000 if single is the gain on sale of their personal residence is what foreign nationals can get. However, a foreign national may be required to file a tax return depending on the property’s sales price. These are some useful tax tips for foreign nationals investing in U.S real estate that you need to keep in mind.
Considering losses on real estate sales
Often, foreign nationals investing in U.S real estate do not like to manage their rental real estate. Therefore, they hire a management company for this purpose. In such a situation, the rental real estate will be a proper ‘passive investment’. This in turn limits any rental losses deductions. If there isn’t any passive income to counterbalance the losses, the aforementioned losses generated by the rental will continue to cumulate over time.
The revoked losses will be used against any other passive income in case other passive income is generated. Any business and rental activity in which you didn’t significantly participate is known as passive income.
Gains reporting and taxation
Taxes must be withheld in case a foreign investment owner has any funds distributed to him or her. Also, withholding will be required, if the activity generating cash distributions isn’t considered as connected to a trade or business. Depending on tax treaties with the U.S, each residence country has different withholding rates. You can search IRS Publication 515 to find the withholding rate applicable for your country. Form 1042 is used to report the funds to the US government. Also, to indicate the funds amount distributed to them as well as the tax withheld, a Form 1042-S is given to the foreign national investing in U.S real estate.
When it comes to gains reporting and taxation, there are many tax tips for foreign nationals investing in U.S real estate. Here is an important tax tip: as a foreign national, you must apply for a taxpayer identification or TIN number on Form W-7 if you want to ensure proper withholding. You must file this form as soon as possible because it can take several months to receive a TIN.
In order to determine whether you need to request a withholding tax certificate for reduced tax or no tax, you must analyze any sales for gains or losses before making the sale. You may get an exemption from withholding tax on the sale if you report a loss on sale. Before the U.S real estate tax is calculated, the real estate of a foreign national is only allowed an exemption of $60,000. Therefore, before buying or investing U.S real estate, foreign nationals should consider proper real estate tax planning.
Finally, we come to the last of the tax tips for foreign nationals investing in U.S real estate. The final tip is planning carefully when purchasing U.S real estate. If you’re a foreign national looking to invest in U.S real estate then you should plan your purchase carefully. In order to avoid any problems, you must proceed with caution when involved in the income generation process of any US real estate. Also, since tax laws may change, you must stay informed about the changes that occur each year.
There you have it—the tax tips for foreign nationals investing in U.S real estate. By considering the aforementioned things, you’ll make investing in U.S real estate easy and profitable for yourself.