Global Real Estate: Transaction Tools

1. Global Real Estate: Transaction Tools Chapter 4: Tax Matters

2. In This Chapter • Taxpayer status—resident and nonresident • Physical and substantial presence tests • Income taxes for foreign property owners • Capital gains tax • Estate tax • Foreign Investment Real Property Tax Act (FIRPTA) • Nontax reporting requirements

3. Taxpayer Status • U.S. citizens and resident aliens pay tax on worldwide income • Nonresident aliens pay tax only on U.S.-sourced income • All real estate is U.S.-sourced • Tax treaties

4. Substantial Presence • Present 31 days in current year AND • Weighted average of 183 days over 3 years including current year, triggered in 3rd year • Qualifies as resident for income tax (not immigration)

5. Taxpayer Identification Number (TIN) • Taxpayer Identification Number • Employer Identification Number (EIN) for corporations • Required for real estate business • Allow 8–10 weeks for application

6. Income Tax for Foreign Real Estate Owners • 30 Percent Withholding OR • Effectively Connected Income (ECI) • Foreign owner may choose • IRS approval needed to switch • Best choice depends on overall tax liability

7. Withholding Agents • Property managers as withholding agents • FACTA • Requires foreign financial institutions (FFIs) and U.S. withholding agents to implement new procedures

8. Taxable Income Net Operating Income (NOI) – Cost Recovery – Interest – Amortized Points = Taxable Income

9. Cost Recovery • Annual deduction for a portion of the cost of an asset • Non-residential real estate—39 years • Residential rental property—27.5 years • Lowers basis • At sale, gain attributable to depreciation is recaptured and taxed at 25%

10. FIRPTA • Buyer must withhold 10% of sale price—not gain—and remit to the IRS within 20 days of closing • Exempt: personal residence under $300,000 (buyer or family member must occupy the residence for 50% of time for 2 years) • Commercial real estate • Investor (or agent) must withhold 30% of gross rental income • 10% of sales price • Changes pending

11. Adjusted Basis Purchase Price + Capital Improvements - Accumulated Cost Recovery =Adjusted Basis Basis for capital gains tax

12. 1031 Tax-Deferred Exchanges • Property must be held for investment or productive use in trade or business; dealer property does not qualify. • Property must be exchanged for like-kind property. • Replacement properties must be identified within 45 days after the relinquished property is transferred. • The exchange must be completed (replacement property received) by the earlier of 180 days or the tax return due date. • Both exchanged and relinquished properties must be located in the U.S.

13. Estate Tax • Exemptions and credits for federal estate and gift tax depend on resident or nonresident status • Figured differently for estate tax • No marital deduction • Noncitizen surviving spouse—even if legal resident—pays tax on total estate including personal residence • Qualified Domestic Trust (QDT) can mitigate impact

14. Forms of Ownership • Direct ownership • Indirect ownership through a U.S. entity • Sole proprietorship • General partnership • Limited partnership • Limited Liability Corporation (LLC) • C Corporation • S Corporation • Indirect ownership through a foreign entity

15. Foreign Ownership: Required Reports • Business enterprises with 10% foreign ownership (BEA) • Subdivisions of 100+ lots (CFPB) • 10+ acres of farm, ranch, timber land, or under 10 acres with $1,000 revenue (USDA Farm Service Agency) • State requirements

16. Key Point Review