Inbound Investment in U.S. Real Estate
Approximately 1 minute reading time. In The Wizard of Oz, Glinda the Good Witch tells Dorothy, “It's always best to start at the beginning – and all you do is follow the Yellow Brick Road.” For tax practitioners advising a non-U.S. investor (“NUI”) on investments in U.S. real estate, the beginning point is the Foreign Investment in Real Property Tax Act (“FIRPTA,”) enacted in 1980. Under Internal Revenue Code, Section 897, “Disposition of investment in United States real property,” FIRPTA treats gains or losses attributable to U.S. real estate in the hands of an NUI as “effectively connected” with a U.S. trade or business, and therefore taxable as U.S. source business income; and second, under Section 1445, the companion withholding tax section, FIRPTA imposes a 15% withholding tax duty on buyers of U.S. real estate whenever the seller is an NUI. Both Code sections involve a multitude of exceptions and special procedures, but the bottom line is that, unlike investments in shares of U.S. companies, investments in U.S. real estate have the effect of pulling the NUI into the U.S. tax net. Careful tax planning can reduce the impact but rarely will eliminate it.
For those advisors of NUI’s wishing to invest in U.S. real estate, you should focus on these objectives:
- Confirming that gains from the disposition of U.S. real estate are taxed not more than once, and that losses are available to offset future gains;
- Structuring the investment so as to maximize the benefit of deductible interest on inbound debt financing, while avoiding excessive U.S. withholding taxes on the outbound interest payments;
- Ensuring that the after-tax proceeds from the disposition of U.S. real estate, can be repatriated to the NUI’s country of origin at little or no additional U.S. tax cost;
- Making the most of any preferential terms available under an income tax treaty between the U.S. and the NUI’s country of origin;
- Avoiding U.S. estate tax consequences should the NUI pass away while holding a U.S. real estate investment. (It is important to note that “treaty protection” may be available for income tax purposes, but not for estate tax purposes.)
These goals can be accomplished with careful planning that must be done prior to the purchase. While the tax profession has developed reliable “templates” for certain kinds of inbound U.S. real estate investments, particularly for U.S. commercial rental properties, no two investors are alike. A careful assessment of short-term and long-term asset and cash flow goals must precede the design of any investment structure. The trend in NUI investment in U.S. real estate shows no signs of slowing down. Following the above objectives will serve you well as you advise your NUI clients.
- Fuad S. Saba