American Real Estate Purchased by non-US investorsPosted on November 26, 2016
Most will say that the United States has served as a beacon for foreign investments and business opportunities for many decades. Growing up in rural Connecticut, I would take the one and half journey to New York City at least twice a month. When the meadows vanish in the rearview, and the buildings start to grow taller and taller, you know you’re in the center of it all when you reach your destination. People from every corner of the world are attracted to America, a relatively strong economy with political stability. The result has been a steady increase in foreign investment. America coupled with strong technological innovation has created a robust consumer demand. After the financial crisis, capitalism has been restored and the U.S. is once again a beacon of safety. However, most foreign investors are generally not able to find useful information about legal structuring for property purchases when they are ready to diversify to America.
The devil is in the detail
Like everyone else, I’m overwhelmed when I hear 7,000 taxing authorities rule the United States, from the Internal Revenue Service down through all fifty states to the thousands of local jurisdictions. Each has its own rules – the only thing in common among them is their lack of consistency and coordination. In my opinion, foreign investors that decide to hold a piece of US real estate directly may opt to structure it as a business entity for the added legal protection.
A tale of two tax regimes
When I bump into experienced investors, they will always tell you about two tax regimes that apply to them as foreign investors. The regimes solely depend on whether the property generates ‘passive’ income or ‘effectively connected’ income.
Passive income you can consider as fixed income. It is subject to 30% tax withholding on gross income unless reduced by some special tax code. Always check your local government for details. Effectively connected income is income that can be shown to be connected to a trade or business, and is taxed on a net income, or after expenses – so it is lower than passive. The tax rates change with higher income and apply to US citizens and foreigners. In almost every situation, it is the foreigner’s best interest to make the effectively connected election when structuring an income-producing real estate transaction. Now let’s get on with the real impact on foreign real estate investors: FIRPTA. Congress passes the Foreign Investment in Real Property Tax Act.
Before this law was passed in 1980, capital gains taxes – the big payout of the sale of property – could be avoided (like in some countries). This was done through legal structuring that configured the transfer of assets as a mere corporate stock transfer. FIRPTA closed this loophole in order to ensure that the sale of US real property interests by foreign investors remained subject to US taxes. Therefore we need to structure properly. And yes, the government requires full disclosure of the citizenship of the person holding the title to the property.
6 Common Structures for Investment by Non-US Investors in Real Property
As a non-US investor, the most practical structures with respect to FIRPTA and the tax regimes are if you own less than 5% outstanding shares of a publicly traded real estate investment trust (“REIT”) or if you hold shares in a privately-held REIT. REITs are good, but they are often riddled with management fees that really “eat” into the investors’ returns. REITs are a good way to indirectly own U.S. medical offices, multifamily apartments, and specific areas of the U.S. You could also own member interests in Joint Venture that holds REIT shares. Another structure is when you are a shareholder of a wholly owned Delaware corporation or if you co-own property with other investors through a Delaware partnership. Delaware is a popular place for business entities because it is owner-friendly and strongly protects the rights of shareholders. And don’t worry, the state you register a legal entity does not necessarily have to be the same state where the real estate is located. Lastly, making an investment through a debt instrument is a viable option for you as a foreign investor.
Keep in mind as the investor you should be protected both in the US and in your home country. Some structures are more expensive to create and maintain, but if your investment portfolio is large enough, the tax savings can more than offset the setup cost and tax filing requirements.
Caterer Goodman Partners can help you understand these different options. For effective and personal tax planning, it is best to consult a lawyer specialized in real estate and in that specific geography where you will be buying. Caterer Goodman Partners works with several professionals across America, from New York to San Francisco, to advise and execute your real estate investment in the United States.
About Caterer Goodman Partners
Caterer Goodman Partners is a Shanghai based wealth management firm established with a clear vision to provide a new level of personalized financial planning services for expatriates in Asia. Our financial advisors provide guidance for our clients in all areas of investment, specialising in managed accounts, money-market funds, retirement planning and alternative investments. At Caterer Goodman Partners, we offer our advice and experience to provide low cost, tax-effective and simple solutions to match our clients' interests.
About Peter Okrasa
I have been a financial advisor for busy expats in China and their families since 2014. I have also been actively consulting private mainland investors since 2012 to help them buy real estate in the USA and other overseas markets. My area of expertise is educating clients to diversify, earn stable income, and grow their capital in accordance to their medium and long term financial objectives. Before coming to Asia in 2011, I lived in the USA and managed commercial property investments worth $30 million in the east coast. In 2007, I graduated from the University of Connecticut with a B.A. in economics.
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