Alan Winston Granwell Paul Marcotte , Jr.

1. February 28, 2017How High Net Worth Foreign IndividualsShould Acquire U.S. Residential Real Estate Alan Winston Granwell Paul Marcotte, Jr. Sharp Partners PA Paley Rothman

2. introduction STEP Mid-Atlantic Chapter

3. Topic to be Discussed • High net worth individuals (HNWI) are typically highly mobile and invest in real estate in various jurisdictions. • Through transactional examples, we summarize the principal issues that tax practitioners have to face when assisting HNWI investing in real estate in the United States. • Focus is on the acquisition, use and sale at a gain of residential real estate. • We will also comment on how U.S. tax reform may impact structures. STEP Mid-Atlantic Chapter

4. Case Study Facts • Non-resident HNWI purchases residential real estate in the United States, uses property when HNWI or family visit the U.S. and, after a number of years, sells the residential real estate at a gain. STEP Mid-Atlantic Chapter

5. Case Study Assumptions • The HNWI is a resident and domiciliary of his/her home country and a non-resident of the country in which the real estate investment is made. • The HNWI satisfies the limitation on benefits article of his/her double tax treaty (DTT), if any. • The HNWI can legally acquire real estate in the other country. • The HNWI is fully tax compliant in his jurisdiction of residence and will use declared funds to invest in the source country; the HNWI will also become fully tax compliant in the source country. • The HNWI and/or family will use the residential real estate for their own use and may rent the property to others. • The purchase and sale of the residential real estate funded through wire transfer from, or draft drawn on, bank account outside of local country (and not cash). STEP Mid-Atlantic Chapter

6. Case Study Issues • We consider principally the national or federal income, and capital gains taxes, estate/inheritance and gift taxes imposed on the HNWI investor and/or his investment vehicle in the source country and the residence country in the following scenarios: • Direct investment. • Investment through a vehicle or combination of vehicles: • Limited Liability Company • Corporation • Partnership or tiers of partnerships • Trust (common law) or foundation (civil law) • In view of likely tax reform in the U.S., the possible tax reform consequences will be considered in discussion. STEP Mid-Atlantic Chapter

7. United states Aspects STEP Mid-Atlantic Chapter

8. U.S. Tax Considerations • Background. HNWI’s investment in U.S. real estate implicates income, gift and estate tax issues, and compliance issues from a U.S. tax perspective. • Income Tax: • Minimize tax rate on sale of residential real estate. • Minimize US tax exposure to constructive distributions with respect to owner use of residential real estate owned through entity. • Avoid double taxation of corporate earnings. • Estate and Gift Tax: • Avoid estate tax upon death. • Avoid gift tax upon inter vivos transfers. • Compliance: • U.S. withholding tax. • Tax returns/statements; contact with US tax system. • Impact under FATCA/IGAs. STEP Mid-Atlantic Chapter

9. Purchase of PropertyBy Foreigners • A person who is not a U.S. citizen or resident can purchase U.S. real estate. STEP Mid-Atlantic Chapter

10. BackgroundGeneral • Ownership of, or the ability to stay in residential real estate, of itself, does not cause a non-U.S. person to become a U.S. resident for U.S. tax purposes; however, under FATCA, a U.S. mailing address is a “U.S. indicia”. • Individual ownership of residential real estate: • Owner use or family use does not require a lease; that is, no income tax consequence to occupation by owner or family. • So too, no gift tax consequences when property used by family members. • Entity Ownership and Imputed Rent: • Necessary to consider whether entity should charge rent for owner or family use (imputed rent). • If rent should be, but is not charged, implicates income and estate tax issues. STEP Mid-Atlantic Chapter

11. Income TaxationIncome and Gains U.S. Source Rent • 30% (or lower treaty rate) withholding tax • “Net” election: Elect to subject rental income to “net” basis taxation in order to utilize deductions. • Consider payment of rent by shareholders: • Funds corporate expenses. • Reduces exposure. STEP Mid-Atlantic Chapter

12. Income TaxationIncome and Gains FIRPTA Gains FIRPTA: Foreign investment in Real Property Tax Act. Gains from disposition of US real property interest (USRPI) taxed to a non-US person on a ”net” basis. USRPI includes Direct interest in U.S. real property (other than solely as a creditor). An interest in a U.S. company holding primarily US real property. FIRPTA applies look-thru rule to partnerships and trusts. STEP Mid-Atlantic Chapter

13. Income TaxationRates and Other Items * Branch Profits Tax Note, 3.8% net investment income tax does not apply to NRAs or foreign trusts STEP Mid-Atlantic Chapter

14. BackgroundGeneral U.S. Estate Tax • Estate tax is a type of death tax that is calculated based on the net value of property owned by a deceased person on the date of death. • Impact of deductibility of recourse and non-recourse debt on property • Applies to US situs assets (see chart next page) of non-resident alien, such as HNWI. • Maximum Rate: 40% • Exemption Amount: $60K. STEP Mid-Atlantic Chapter

15. BackgroundGeneral U.S. Gift Tax Gift tax applies to lifetime gifts. Applies to transfer of US situs assets (seechart next page) of non-resident alien, such as HNWI. Maximum Rate: 40%. Annual Gift Tax Exclusion Amount: $14K (indexed for inflation). Special annual exclusion for gifts to non-US citizen STEP Mid-Atlantic Chapter

16. Estate and Gift TaxProperty Subject to Tax * Law is not settled as to whether US LLC interest or US partnershipis includible for US estate tax purposes ** LLC/partnership owning US real estate, likely no taxation Note, table above is not comprehensive STEP Mid-Atlantic Chapter

17. Background Compliance • The acquisition and disposition of U.S. real property interests under FIRPTA implicates a complicated set of withholding rules, certifications and tax return filing obligations, depending on the circumstances, which are beyond the scope of this presentation. • As an illustration, a non-U.S. purchaser is a withholding agent for purposes of FIRPTA and must obtain a certification of non-foreign status or withhold 15% of the purchase price (generally). • Apart from the foregoing, a non-U.S person acquiring, deriving income and/or disposing of U.S real estate also must be aware of the corollary, state, city and local rules relating to the reporting and payment of tax. STEP Mid-Atlantic Chapter

18. Individual Ownership • Simplest Structure. • Owner or family use of property does not require lease. • Only one level of tax. • Income Tax: • If lease to third party, rental income subject to U.S withholding tax or net basis taxation. • Capital gain on sale taxable @ 20% • Estate Tax: • Yes (over $60K). • Consider insurance to cover estate tax. • Probate (costly and time consuming). HNWI Residential Real Estate STEP Mid-Atlantic Chapter

19. Single Member LLCOwnership • U.S. LLC structure can shield owner of LLC from legal liability generally. • Single member U.S. LLC disregarded for U.S. income tax purposes • Income Taxation: same as if owned by individual directly. • Estate Taxation: • If LLC organized in U.S., answer not entirely clear. • If LLC organized outside of U.S., answer not entirely clear. • Comment: U.S. LLCs often treated as corporations by non-U.S. tax authorities, creating tax mismatches (e.g. Switzerland). HNWI LLC Ownership Residential Real Estate STEP Mid-Atlantic Chapter

20. Corporate OwnershipIn General • Many corporate ownership variations exist: • Use of U.S. corporation • Use of non-U.S. corporation: • Treaty protected. • Non-treaty protected • Combination of foreign corporation owning US corporation, • Use of corporation has advantages and disadvantages: • Advantages: May avoid U.S. estate tax, depending on structure • Disadvantages: • Corporations not eligible for advantageous capital gains rates. • Real estate gains taxed at corporate rates, highest of which is 35%. • Lease generally required regardless of who uses property. • Double taxation may result. • U.S tax compliance. STEP Mid-Atlantic Chapter

21. Use of Non-US Corporation to Avoid U.S. Estate Tax • A non-U.S. corporation that is properly structured and maintained can insulate a non-resident individual against the U.S. estate tax • Do’s • Have non-U.S. corporation acquire U.S. residential real estate directly. • Adhere to all corporate formalities. • Don’ts • Don’t have non-resident individual acquire U.S. residential real estate and transfer it to the non-U.S. corporation. • Don’t treat corporation as your nominee or alter ego • Don’t ignore compliance with all corporate formalities, payments and filing fees. • Otherwise, corporation could be disregarded. STEP Mid-Atlantic Chapter

22. Corporate OwnershipThrough Non-U.S. Corporation • Estate Tax: • Eliminates exposure to U.S. estate tax • Income Taxation: • No w/h on constructive dividend. • If leased, 30% (or lower treaty rate) withholding tax applies to rental income and branch profits tax, if company makes ”net” taxation election. • If FCo sells real estate, capital gain • If HNWI sells stock of FCo, no U.S. tax but (implied discount because of FCo ownership). HNWI FCo Residential Real Estate STEP Mid-Atlantic Chapter

23. Corporate OwnershipThrough U.S. Corporation • Not a tax efficient structure. • Owner or family use requires an arm’s length lease. • Income Tax: • USCO taxable on all of its net income reduced by deductions). • Rental income from owner lease. • Third party rental income. • 30% withholding tax (or reduced treaty rate) imposed on dividends • No BPT. • Capital gain at sale taxable @ 35%. • Estate Tax: • USCO U.S. situs asset. • HNWI subject to US estate tax. Individual USCo Residential Real Estate STEP Mid-Atlantic Chapter

24. Corporate OwnershipTwo-Tier Structure • More complicated and expensive structure to avoid estate tax and BPT. • Owner or family use requires an arm’s length lease. • Income Tax: • USCO taxable on all of its net income reduced by deductions) • Rental income from owner lease. • Third party rental income. • 30% withholding tax (or reduced treaty rate) imposed on dividends. • Capital gain at sale taxable @ 35%. • Estate Tax: None. Individual FCo USCo Residential Real Estate STEP Mid-Atlantic Chapter

25. Corporate OwnershipTrap for the Unwary • Fact Pattern: HNWI establishes a US corporation to own US residential real estate and thereafter wants to transfer (i) ownership of the assets or (ii) stock to a foreign corporation to avoid US estate tax exposure • Result: Restructuring is a US “inversion” and F Corp will be treated as a US corporation for US tax purposes Before After Individual Individual Residential Real Estate U.S. Corp F Corp U.S. Corp STEP Mid-Atlantic Chapter

26. Partnership StructureTwo-Tier • Structure to obtain individual capital gains rate and avoid US estate tax. • Law not entirely clear but a number of advisors believe little risk of U.S. estate tax exposure. • Self-use of property does not require lease if real estate purchased by partnership; if not, lease. • Income Tax: • Flow-thru taxation of income and gain. • Capital gains taxed @ 20% for individuals. • Estate Tax: Not totally clear. HNWI HNWI#2/FCo 99% 1% F 99% U.S. 1% Residential Real Estate STEP Mid-Atlantic Chapter

27. Trust StructureIn General • An irrevocable trust, if properly structured, can avoid US estate tax exposure and preferred capital gains at a 20% rate. • Considerations: • U.S. or foreign trust. • Caveats: • Settlor should not fund trust in U.S. with cash; rather, fund through wire transfer from, or draft drawn on, a foreign bank account. • Trust should not be a “grantor” trust. • Settlor should not be beneficiary of the trust and not use trust property unless he/she pays fair market rent to the trust, except where spouse is beneficiary and rely on precedent that rent-free use of property contemporaneously with spouse beneficiary is not a retained interest. • For HNWIs who live in civil law jurisdiction, a trust is unlikely to be recognized as a legal structure in their home country. Alternative wealth transfer vehicles such as private foundations are not clearly understood from a U.S. tax perspective and need to be carefully analyzed. • Has trust acquire real estate directly? STEP Mid-Atlantic Chapter

28. Irrevocable TrustStructure • Use of an irrevocable trust structure, can avoid U.S. estate tax. • Lease may be required, depending on facts. • Consider LLC to hold real estate. • Income Tax: • Trust is a flow-thru entity. • Capital gains taxed @ 20%. • Estate Tax: • Avoids probate. • If settlor does not have retained interest, U.S. estate tax can be avoided. Settlor Beneficiaries (other than Settlor) Use of property Cash Trust LLC Residential Real Estate STEP Mid-Atlantic Chapter

29. Finals CaveatsClient Due Diligence • With the advent of CRS and the current non-participation of the U.S. in that initiative, the U.S. has been touted as a tax haven and tax advisors and others are recommending that clients desirous of avoiding CRS reporting shift their investments to the U.S., in large part because the U.S. affords privacy through trust structures and various other means, whereby asset values would generally be protected from disclosure and reporting. This strategy creates risk for the advisors. • The facilitation of foreign tax evasion is a crime, Pasquantino v. U.S. 544 U.S. 349 (2005). Thus, under this Supreme Court case, U.S. law firms, accounting firms, financial firms, banks, and their high level employees and perhaps foreign advisors, are at risk for prosecution in the U.S. or abroad if due diligence procedures are not in place to identify and prevent such facilitation. It is no longer sufficient to just be in compliance with one’s own country laws. STEP Mid-Atlantic Chapter

30. Final Caveats FINCEN Reporting • The Financial Crimes Enforcement Network (FinCEN) announced an expansion of the Geographic Targeting Order (GTO) targeting alleged money laundering risk in the real estate sector. • The new GTOs will temporarily require U.S. title insurance companies to identify the natural persons behind shell companies used to pay "all cash" for high-end residential real estate in six major metropolitan areas. In announcing the new GTOs, FinCEN explained that it remains concerned that all-cash purchases (i.e., those without bank financing) may be conducted by individuals attempting to hide their assets and identity by purchasing residential properties through limited liability companies or other similar structures. • The new GTOs will be effective on August 28, 2016 for 180 days and cover the following areas:  (1) all boroughs of New York City; (2) Miami-Dade County and the two counties immediately north (Broward and Palm Beach); (3) Los Angeles County, California; (4) three counties comprising part of the San Francisco area (San Francisco, San Mateo, and Santa Clara counties); (5) San Diego County, California; and (6) the county that includes San Antonio, Texas (Bexar County). The monetary thresholds for each county vary from $500,000 to $3 million. STEP Mid-Atlantic Chapter

31. Final Caveats New U.S. LLC Filing Requirements • U.S. LLCs with a single owner, a common structure used in investment in U.S. real estate, will have to report information to the IRS starting in 2017. • In order to provide transparency and aid U.S. information exchange with foreign governments, the IRS finalized regulations, requiring U.S. disregarded entities (LLCs) to apply the 25% foreign-owned domestic reporting requirements. • This only will apply for reporting purposes. • Under these rules, a wholly owned LLC, which is transparent for U.S. tax purposes, now will be required to report its name, principal place of business, nature of business, and country or countries of organization of related parties that transact business with the reporting company. • If these reporting requirements are not timely and properly complied with, the statute of limitations remains open. STEP Mid-Atlantic Chapter

32. Thank You Alan Winston Granwell Sharp Partners PA Washington, DC agranwell@sharptaxlaw.com +1 202 872 1800 Paul Marcotte, Jr. Paley Rothman Bethesda, MD pmarcotte@paleyrothman.com + 1 301 951 9368 STEP Mid-Atlantic Chapter