US Property: A Short Tax Guide for Overseas Investors

More and more international investors are putting money into the US property market. Data from Real Estate Analytics shows that, in the first eight months of last year, …

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More and more international investors are putting money into the US property market. Data from Real Estate Analytics shows that, in the first eight months of last year, almost US$23 billion flowed into the US real estate market from non-US buyers.

Meanwhile, a survey by the Association of Foreign Investors in Real Estate recently identified the US as a definite leader in international property investment, with the considerable majority of respondents intending to increase their exposure to this market.

This makes US property look like a very attractive prospect, and it certainly has the potential to live up to this image. Before considering investment in the US property market, however, it is necessary to understand the tax situation.

Tax Impediments on Foreign Property Investment

Unlike foreign investments in the US stock market, for example, real estate investments from overseas buyers are generally taxable in the US. In 1980, the US enacted the Foreign Investment in Real Property Tax Act (FIRPTA). This subjected international investments in property to significant tax liability. Combined with later acts and amendments, this largely means that property investments from foreign buyers are treated as Effectively Connected Income (ECI). Rental returns and gains from property sales are usually taxed at the same rates that would apply to US citizens, and overseas buyers must fill out US tax returns. In some circumstances, investors in Real Estate Investment Trusts (REITs) can be subject to similar tax rules on capital gains dividends and stock sales.

There may also be additional, non-US tax impediments and responsibilities applying to non-US holders of US property. This will almost certainly relate to your home jurisdiction and issues such as reporting your income from your US holdings.

Tax-Efficiency

A number of structures and other tactics exist that can help overseas investors legally minimize their US tax liabilities. For example, Real Estate Investment Trusts provide a number of tax advantages, despite still being subject to FIRPTA in certain circumstances. Despite being a corporation for most legal purposes, they are not generally taxed as such. Rental income payments are treated as dividends, and certain ordinary dividends may be subject to more favorable tax rules under US treaties. Gains from disposal of properties, however, will still be treated as ECI.

Non-US citizens may also choose to invest in US property as lenders for a tax advantage. A loan secured against real estate will not usually be treated as a US property interest, even if the property it is secured against is located in the US, and this can provide exposure to the US property market in a tax-efficient way. If the loan participates in appreciation, with will be treated as a property interest but, if properly structured, will still be taxed more favorably.

Alternatively, tax advantages may be gained by the use of an offshore blocker. By holding shares in a domestic corporation and lending to it, with the blocker investing those funds in property, can be more tax-efficient than investing directly.

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