As per American tax laws a foreigner is generally defined as any individual who is neither a U.S. citizen nor a national of the U.S. He or she may be a classified as either a non resident alien or a resident alien. while a non-resident alien is someone (does not apply to a US national or US citizen) who has not passed the ‘substantial presence test’ or the’ green card’ test. Furthermore, non resident aliens are also those people who are legally present on United States territory but do not possess a valid green card. Such a category includes students, tourists etc. or any other visitor to United States territory, who is in possession of a valid visa for a fixed time period only. (Such as 5 year multiple entry and exit visas).
Foreigners Who Have Entered the United States Territory Illegally
These are those foreign nationals who have managed to gain ingress into the territory of the United States by evading border security and as such do not have a valid U.S visa. Such people are outside the scope of all IRS (including FIRPTA as well as other laws regarding the purchase and sale of tangible property in the United States) laws since they do not have either Social Security Numbers or Individual Taxpayer Identification Numbers and are therefore , completely outside the tax net altogether. These people have not just entered US territory illegally but their stay there is also entirely in contravention of state, local and federal laws. If apprehended, they are sent to deportation centers and subsequently deported to their country of origin. This is why they have no legal right to either sell or purchase property in the United States and therefore have no tax liabilities whatsoever with regard to any monetary transactions they may have conducted during their stay in the country.
Before understanding the rules and regulations regarding capital gains tax regarding the sale and purchase of real estate by foreigners in the United States, we have to come to an understanding of the very concept of capital gains tax.
Taxation on Capital Gains on All Incomes Accrued by Foreigners
In terms of all capital gains (here a capital gain may be described as an overall increase in the value of a capital asset, such as an investment in stocks or commodities that is actualized only when the asset is sold for either a profit or a loss, as the case may be) that are accrued by foreigners. Here it is pertinent to note that these are not subject to U.S. capital gains tax on the profits that said individual of foreign origin may have actually gained from this sale.
Since such a tax is not applicable to the foreign country based investor/shareholder, no tax may either be deducted from his or her accrued income or withheld at source by either the brokerage firm or the agent acting on behalf of such a firm or company.
However, this cravat does not authorize the foreigner to have a blanket ‘white paper’ to continue to trade without being made to pay any form or type of taxes whatsoever. This is because he or she would inevitably be taxed in his or her country of origin and/or current residence.
Here it is important to clarify that all dividends payable (that are applicable to all stock and shares owned by a foreigner) are subjected to the universal dividend tax rate of thirty percent. This tax is applicable on any and all dividends that are paid by joint stock companies incorporated in the United States, to all their share holders, even including residents of foreign countries. Such dividends may be paid by joint stock companies who may be divesting their real estate assets.
Nevertheless, it is pertinent to point out that, such dividends may be beyond the ambit of this 30% tax if the dividends are paid by overseas companies or alternately, if all of the above mentioned dividends are short term capital gain dividends or even interest related dividends.
In addition to the above, this thirty percent flat rate is also subject to certain terms and conditions that are entirely dependent on the treaty obligations between the country of origin of the foreigner as well as the government of the United States.
This is why when we consider the taxation policies for people of foreign origin it is imperative to read and understand all the relevant treaty obligations between the home country (of the foreigner) and the United States. This holds especially true for people from India as well as many South Koreans because these two countries have also signed multiple tax related treaties with the U.S government.
FIRPTA (The Foreign Investment in Real Property Act)
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) was enacted as Subtitle C of Title XI (the “Revenue Adjustments Act of 1980”) of the Omnibus Reconciliation Act of 1980, Pub. L. No. 96-499, 94 Stat. 2599, 2682 (Dec. 5, 1980),
As per this law, it is mandatory for all foreigners (irrespective of their country of origin) to pay a stipulated amount of income tax on individuals of foreign origins when they set about disposing of any and all “ Real” property that they may hold in the United States. (Here real property denotes both land and the articles permanently attached to the land. Said articles are often colloquially referred to as “improvements” and may include homes; such as an apartment or a bungalow as well as garages, and buildings.)
In such sales the tax liabilities applicable to the foreigner are calculated at the at regular tax rates after vectoring in, the type of taxpayer involved along with the total amount of profit (or gain) that has been accrued from the sale of the real property thereof. A point to be noted here is that said profit has to be considered ‘recognized’ for tax purposes.
As regard the requirements for foreign purchasers of real property interests, (such as a whole property or portions of it; these portions may be divided into apartments of a particular building or alternately the whole building itself) include the withholding of tax at the time the taxpayer makes a lump sum payment for the property. Here, there is a cravat that the withholding tax may be reduced from the set standard of fifteen percent to a sum that will cover the (cumulative) tax liability, upon application (in advance of the sale itself) to the IRS.
It should be noted that FIRPTA is an all encompassing statute that essentially overrides most nonrecognition provisions (By which it is meant that the statute’s provisions are applicable in either one of two cases or alternately, both of them. The 1st case in which nonrecognition is conferred is related to the sale or exchange of a property that ‘usually’ involves a simple change in the form of an investment rather than an actual change in the very substance of that particular investment alone.
In the 2nd case, the cumulative profit so realized never actually disappears: the (as yet) unrecognized profit or loss is usually carried forward into the new asset per se. When this new asset is subsequently sold or exchanged in any sort of taxable transaction, then the (cumulative) realized profit or loss from the first transaction will formally be recognized, as well as those remaining tax treaties that provide exemption from tax for such accrued profits. (Such treaties are usually applicable to citizens of Indian and South Korean origins)
As per the law, as it is practiced in the United States all persons are required by the abovementioned law (applicable to both foreigners as well as American nationals and citizens) to pay a certain amount of income tax on dispositions of interests (either full or partial) in U.S. real estate (U.S. real property interests). American nationals are subject to this tax as part of their regular income tax (according to Internal Revenue Code sections 897 and 6039C that were enacted as part of the overall FIRPTA law). Furthermore, the Act also made several conforming amendments to various other provisions of the Internal Revenue Code that are applicable to foreigners at this point in time.
When it comes to US capital gains tax on real estate for foreigners as per the FIRPTA act, a point to be noted is that all individuals of foreign origin will be subjected to tax only on certain types of income that may include income generated only though certain U.S. source as well as effectively connected income. Here it is relevant to point out that as per this act such foreigners are however, not taxed on most capital gains (and profits). In fact, the local Internal Revenue Code section 897, as enacted by the FIRPTA act of 1980 treats the profit accrued therein, quite simply as a disposition of an interest in United States real property as a form of ‘effectively connected income’ that by itself is subject to the relevant federal income tax statutes.
In this regard, the FIRPTA act requires foreign buyers of U.S. real property interests to withhold fifteen percent of the sales price of the property so as to ensure tax collection from all foreign taxpayers who are purchasing the aforementioned real estate. It is entirely up to the seller of the property to apply to the IRS to reduce the required fifteen percent tax (as mandated by the law) to the minimum amount of tax that is estimated to be due as a result of the transaction. As a rule, the ‘Internal Revenue Service’ routinely approves all such seller applications, with alacrity.
The FIRPTA Act and Its Application
This law applies in almost all such cases where a foreign owner of a U.S. real property interest disposes of that interest (either completely or in part). However, many provisions of the law which would prevent recognition of the profits so accrued from the transaction do not, as a rule apply to either the buyer or the seller till the latter receives a U.S. real property interest in a qualifying nonrecognition exchange (of real estate and other tangible property as the case may be).
Tax Implications for Foreigners
All tax assessments for any foreign individual (irrespective of country of origin) will depend on that foreigner’s classification as either a non-resident or a resident alien.
In the case of all non-resident aliens, the individual concerned would be subjected to certain criteria, some of which also include:
- The non resident alien person cannot be in possession of a valid green card at any time during the relevant period under assessment (Generally taken to mean at most a single calendar year)
- A non resident alien must not have resided in the U.S. for more than 183 days (maximum) in the preceding 3 year interim period. (This would also include the current reporting and assessment year as well).
Here it is pertinent to note that all non-U.S. citizens who are in possession of valid green cards (a term often colloquially used for a United States Permanent Resident Card) and have been on United States territory for a period exceeding at least 183 days would be considered to be resident aliens, at least with regard to the evaluation of their tax returns, and as such would have to follow all the rules and regulations in place that govern the tax returns of all resident aliens in United States under the existing laws regarding capital gains on disposal and purchase of real estate by said foreigners (As and when applicable).
Here if any foreigner in the United States on a valid visa for a limited period of time were to be classified as a ‘non-resident alien’ and his only business activity would consist of the involvement in the trading and holding of non tangible trading assets as opposed to tangibles such as real estate, property machinery etc. (such as mutual funds, stocks, commodities and other associated non tangibles ) within the ambit of a United States dollar denominated brokerage firm or any other agent operating as per the same guidelines, then such an individual’s income would be considered to fall under the domain of the capital gains principles as mentioned above.
Factors That Foreigners Have to Contend with When Opting to Purchase Property in the U.S
Since the United States is widely considered to be a key hub for international commerce and trade, many foreigners are attracted to the country and they continue to buy real estate for both commercial as well as residential purposes in ever increasing numbers, even as of today. However, few (if any are aware of the many legal and tax related implications of making such purchases at both the federal as well as the state level. In fact, for many such people the whole idea of being able to navigating through U.S. tax rules and regulations is fraught with hazards and nervous tension akin to crossing a veritable minefield. Apart from the FIRPTA act there are a whole host of other considerations (such as the different classifications of foreigners into resident and non resident aliens for instance) that include, title insurance the rules governing the basic principles of escrow as well as many other different special tax rules. This is why it is absolutely imperative to hire the services of a tax adviser of sound repute before wading into such uncertain waters.
One such issue that is being faced by many foreign individuals when dealing with US capital gains tax on real estate for foreigners is the key decision as to how to go about taking the title of the property being considered for purchase. Yes just about every one (either US national or foreigner) would want the property to be titled in his or her own name. However, that may not be as easy for a foreigner as it generally is, for a US citizen.
However, once they (individuals of foreign origin) are able to establish their title over a US based property they would be glad to know that should they wish to sell the aforementioned real estate; any profit that they accrue from the sale of this property, will be taxed at the long term capital gains rate of only fifteen percent if the real estate was held for a period of at least one year, or more.
Nevertheless an important point to be noted here is that the foreign buyer who holds the title in his name may typically end up taking a huge risk from the point of view of his dependents and inheritors, because were he to pass away while still owning the title of his real estate in the United States, and if the total value of the property were to exceed a minimum amount of $60,000, then it would be subjected to an extremely high tax rate often up to as high as forty five percent.
However, this cravat is applicable only to foreigners, since the inheritors of legal U.S. tax residents, holders of valid green cards as well as American citizens, need not pay such high tax rates.
In this regard, if the total value of the property is estimated to be less than two million dollars (at least) they will not be subject to the U.S. estate tax. Furthermore, Both U.S citizens as well as holders of a valid permanent residency card have the option of being able to pass on all their estate to their spouse completely tax free. However, for this purpose the marriage has to be considered legal under existing US laws and verbal marriages as per tribal, cultural and religious customs of the country of origin of the foreigner are not generally considered valid under the law as it applies to United States territory.