Special Notes for overseas investors in USA real estate

The tax laws on overseas investors in US real estate are sophisticated and draconian. Make sure you get competent professional advice before even make a simple investment such as a vacation home. The following is a brief overview.

Income taxes

If you rent our your real estate investment your income will be taxed.

1. You can elect to have the gross income taxed at a flat rate or file a tax return. The flat rate will be at 30% (but you may get some help from tax treaties to prevent taxation twice on the same income). The flat rate option will not allow you to deduct expenses such as maintenance, mortgage interest, electricity or water. The US person who withholds the tax must file an annual Form 1042 and 1042S.
2. Or it can be taxed as effectively connected US source income. Then you will have to file a 1040NR tax return but will be able to deduct for expenses associated with that income. This option is the sensible choice unless the income you generate is very low.
3. Under US tax law, you can depreciate the property, there are different rates for residential and commercial properties. This annual depreciation is deducted from your income as an expense on your tax return. But it will be recaptured when you sell. See below.
4. If you invest in mortgages secured on US properties, your income will also be subject to tax. This would be subject to tax treaties that are intended to avoid double taxation. If the lender is from a country that does not have a tax treaty with the United States, withholding tax should be deducted at the appropriate rate, usually 30%. However it is possible for mortgage income to be characterized as portfolio income that is not subject to withholding tax. See page 14 of IRS publication 519 (see below) and a GOOD international tax attorney.

Capital gains taxes

Unlike many countries, such as the UK, the US government also wants it's share, or more than its share, when you sell the real estate.

There is an especially nasty law called FIRPTA. (Foreign investors real property tax act.) The US government is very worried you will sell the property and skip the country with the money. Under FIRPTA, the US persons handling the transaction is required to withhold 10% of the GROSS price, even if you have not made a profit. It is possible to get an advance clearance from the IRS, but allow several months.

There is an exclusion to this, which the closing agent may not be aware of. That is if the property is sold for less that $300,000 AND the buyer (or family member) is going to use it as a personal residence. See the Act for the exact requirements. Then no withholding tax need be deducted. But you will still have to pay capital gains tax if it is owing.

The rate of capital gains tax is is slightly higher on the re-captured depreciation element of your gain.

If FIRPTA applies you can reclaim any excess deducted by making application to the IRS. Again allow several months.

Estate taxes

Variously known as death duty, inheritance, capital transfer taxes. Here the non-resident gets far worse treatment than the US citizen or permanent resident.

The US citizen has a 100% allowance on bequests and gifts to their spouse and very generous limits on transfers to other parties.

But this drops to just $10,000 if you are foolish enough to be a foreigner who dies while owning US situs real estate. There may be some sort of relief through double tax treaties.

The estate taxes also apply to mortgages secured on US properties.

To download a copy of the IRS publication 519, which covers non residents, click here.

To download a copy of the IRS publication 515, which covers withholding from non residents, click here.

Again, the subject of overseas persons investing in US real estate is a minefield. The above is intended to be accurate but is not guaranteed or intended to replace competent  legal and tax advice from professionals in this field.
 

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