Canadians Purchasing US Real Estate
Bargain U.S. real estate prices have attracted many foreign investors. Foreigners or non-residents can buy property in the USA. Condominiums and single-home buildings are especially popular among foreign investors in USA real estate. The acquisition structure like a trust, domestic LLC or a corporation can provide liability protection and US tax planning advantages.
Are foreign buyers of American real estate subject to US income tax?
Foreign investors must timely file US tax returns for non-residents. Non-residents with US real estate will be subject to tax at ordinary rates on net rental income. Net rental income is calculated as a difference between gross rent and real estate expenses. To take advantage of numerous deductions, it is crucial to timely file US federal and state tax returns for each year of ownership whether or not a foreign person actually has an income tax liability. This is why tax planning is important. Foreign investors can loose all deductions and will be taxed on the gross rental income received if they fail to submit US tax returns.
For example, a non-resident alien with USA real estate holdings earns $30,000 in gross rental income and has $10,000 in rental expenses in 2012. This foreign person timely files a federal tax return. In this scenario s/he will be required to pay $2,000 US income tax on net rental income of $20,000. If this foreign investor doesn’t file a federal return timely, then s/he will have to pay tax on $30,000 gross rental income.
Foreign investors must pay a capital gains tax and a FIRTPA withholding tax. As of 2013, singles earning over $400,000 and couples earning over $450,000 have a long-term capital gains rate of 20%. When calculating the capital gains tax, you should subtract the original purchase price, closing costs, and capital improvements/renovations from the gross capital gain.
A foreign seller is also subject to a Foreign Investment in Real Property Tax (FIRPTA).
Under FIRPTA, the buyer must withhold 10% of the gross proceeds from a foreign seller’s property sale. It is important to remember that this is not an actual US tax due. If a foreign seller is current on all US tax returns and there is no outstanding US tax liability like income tax or capital gain tax, then a foreign person should receive a refund of the 10% that was withheld at the sale. In case of trust with foreign beneficiaries and foreign corporation a withholding tax is 35%.
Foreign investors in USA real estate are subject to Federal estate tax. U.S. citizens are eligible to claim an individual exemption from the estate tax up to $5 million. This number is $10 million for married couples. However, foreign persons don’t qualify for this exemption. It is important in the tax planning step to check a tax treaty between the USA and this foreign country. This helps to minimize a US tax liability.
Choosing a right acquisition structure whether it is a domestic LLC, trust or corporation depends on multiple factors. We advise foreigners/non-residents to work with a CPA who deals with non-resident tax issues and can help them navigate US tax law. To contact international tax experts at Artio Partners, please click here.