23 March 2018
It’s a good time to buy real estate in the United States. Recent problems in the subprime mortgage market have driven prices down. For international families, it may make sense to buy an American property if a family member will be spending significant time in the United States on business or studying at an American university.
A few caveats, though. Before jumping into the U.S. real estate market, families and family offices need to assess carefully the implications of owning property there – and eventually disposing of it. There is a complex set of U.S. tax rules governing ownership and disposition of real property by non-resident non-citizens (NRNCs).
For any transaction involving a foreign national and real estate, whether that person is an NRNC or not, it’s likely that FIRPTA (Foreign Investment in Real Property Tax Act) will come into play. Enacted in 1986, FIRPTA was fashioned to ensure that foreign nationals pay tax on their investment gains in the U.S. real estate market.
FIRPTA is not a tax in itself, but rather a set of provisions that govern whether and how a transaction involving foreign ownership of U.S. real estate is taxable. The form of ownership, and the choice of property, can make a substantial difference in the amount of tax an NRNC may owe upon the sale of U.S. real property.
Buying a residential property in New York City, for instance, poses a range of choices. Much of the residential real estate in Manhattan is in the form of either co-operative apartments or condominiums. Each form of ownership has separate rules, along with significant differences in implications for taxation and estate planning.
Issues that would-be buyers need to consider include:
- The purpose of the property. Will it be a full-time residence? A pied-à-terre? A long-term investment? Will it be used for personal or business purposes?
- Who will live there? A family member? Business associate? Occasional guests?
- The legal status of the owner. Will he or she qualify as a an NRNC? The IRS has a formula for determining this, based on the number of days a person resides in the country, his or her intentions, the comparative space and value of all the person’s residential properties, how they are furnished, and family ties.
When it comes to taxation, buyers need to think ahead to the eventual sale of the property. Any time a foreign national transfers an interest in real estate in the United States, the transferee is obliged to withhold ten percent of the gross sale price. This potentially applies not only when non-U.S. individuals sell real estate, but also to non-U.S. corporations, trusts or partnerships holding U.S. real estate. Even if these entities hold other assets in addition to U.S. real estate, the IRS will look carefully at the percentage of the entity’s holdings that constitute U.S. real property interests (USRPIs). USRPIs can include stock in a U.S. or Virgin Islands corporation if 50 percent or more of their assets are U.S. real property, as well as undeveloped land, crops, minerals or mines. To trigger FIRPTA’s provisions, three elements must be present:
1. There must be a USRPI;
2. The USRPI must be disposed of;
3. The party that disposes of the USRPI must be a foreign individual or corporation.
In New York City, condominiums are owned as real property, along with a contract among the owners for shared ownership of common areas. Co-ops, on the other hand, are not owned as real property but as shares in the corporation that owns a building. Many co-ops do not allow corporations or trusts to own shares, while condominium governing boards may allow ownership through a foreign trust or holding company.
This presents tax-saving opportunities by allowing an NRNC to buy a condominium apartment through a foreign trust or holding company. Before acquiring property in the United States, it’s important to look at all these issues and to structure ownership in a way that keeps exposure to gift, estate and FIRTPA taxes to a minimum. Our firm has experience in structuring real estate ownership for U.S., U.K. and multinational families. We understand that each family presents a unique set of circumstances. We work toward balancing their residence requirements with their estate planning needs and to structure ownership of real property to the family’s advantage.