Introduction to Taxation of Foreign Investment in U.S. Real Estate

2. Webinar Overview: • Introductions to US Real Estate investment by Foreign Investor • FDAP income (Not trade or business income) • Effectively Connected Income (ECI) • Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) • Choice of proper investment structure and tax planning • Tax Implications for • o Rental income tax • o Capital Gain tax on eventual disposition of property • o Estate/Gift tax consequences • 7. Other consideration • o Anonymity – Non disclosure of identity • o Assets protection • o Simplicity of structure to balance against complexity costs.

4. Who are Foreign Investors? • A Foreign investor is a non-resident alien individual who is • Not a U.S. Citizen • Does not have Green Card • Does not meet the “Substantial Presence Test”: • To meet this test, a person must be physically present in the United States on at least: • 31 days during the current year, and • 183 days during the 3-year period that includes the current year and the 2years immediately before that, considering: • All the days a person was present in the current year, and • One-Third (1/3) of the days a person was present in the first year before the current year, and • One-sixth (1/6) of the days a person in the second year before the current year. • A Foreign investor is also foreign entity (Corporation, trust, partnership etc

5. FDAP income and Effectively Connected Income • Fixed or determinable annual or periodic income (FDAP) income also subject to tax by the US • This includes interest, dividends, rent, etc. • The default classification for rental income is FDAP income. • FDAP income is generally subject to a flat 30% tax (or lower treaty) rate on “Gross income” and deductions are not permitted. • Non-Residents are taxed in the US on income effectively connected with a US trade or business (ECI) on a NET basis • Trade or business is not defined in Code/regulations but is any profit motive activities carried on in the US on a regular, substantial, and continuous basis are classified as trade or business for these purposes.

6. Nonresidents – Election to treat real property income as ECI: Nonresident are permitted to file an election under Sec. 871(d) for individual and Sec. 882(d) for corporations to treat income generated by US real property as ECI Property must be income producing for election to be made Election cannot made if property producing expenses but no income Election remains in effect all subsequent years until revocation

7. Reg. 1.871-10(d)(1)(ii)- ECI election • Schedule of all the nonresident’s US real property (and level of ownership) • Location of each real property • List of improvements, and • Information on prior net elections • Real estate held by partnership – election made by partners (rather than at the partnership level)

8. Disposition of US Real Property Interest - FIRPTA General Rules The sale, exchange, or transfer of United States Real Property by foreigners may be subject to special withholding. The amount of withholding required is typically 15% of the sales price. IRC 1445 - Buyer is responsible for making sure the IRS receives the withholding Tax within the 20 days period. Payment of withholding tax is sent to IRS with form 8288 and 8288-A Part I is competed if the buyer is an individual person Part II is completed if an “Entity” is the buyer

11. Withholding Exemption/Reduction • Withholding is not the tax itself, and hence less taxable gain or loss on sale causes cash flow problem due to withholding. • This exemption is exemption/reduction from withholding and not from tax/tax filing. • Under some circumstances, withholding may be reduced or eliminated. • Buyer intends to use the property as residence at least 50% of time in 2 years from closing • Buyer must be an individual • Sales price $300,000 or less - 0% Withholding Tax • Sales price 300,001 - $1,000,000 - 10% Withholding Tax • Sales price more than $1,000,000 - 15% Withholding Tax

12. FIRPTA withholding Options: • Request a Reduction of Withholding Certificate Prior to Closing • Allow Withholding to Occur and Request a Claim of Refund by filing the Non-Resident Income Tax Return Request a Reduction of Withholding Certificate – Form 8288-B • Treas. Regulation 1.1445-3 • Treas. Regulation 1.1445-6 • Rev. Proc. 2000-35 • IRS Publication 515 • Prepare Form 8288-B • Prepare Attachment to Form 8288-B • Calculation of capital gain tax • If rental property, calculation of depreciation recapture and suspended passive losses, if applicable.

13. Allow Withholding to Occur and Request a Claim of Refund by filing the Non-Resident Income Tax Return • File Form 1040NR • Must have stamped Copy A of Form 8288-A to get refund back from IRS • If foreign person does not have ITIN they need to obtain one

14. If a Non resident owns US Real Property through 100% owned LLC, can they avoid FIRPTA? • The answer is NO • Starting in 2017, all foreign-owned Single-Member LLCs that are Disregarded Entities are now treated as Corporations for federal reporting requirements (submitting information) to the IRS. This doesn’t mean the LLC is paying tax like a Corporation, but rather, it’s simply reporting information like a Corporation. • So, you may have to file Form 1120 page 1 and Form 5472 – Failure to file penalty is $25,000 • In addition, there is New FinCen Form for Beneficial Ownership Disclosure starting in 2022. – Failure to file penalty is $10,000

15. If I make a 6013(g) election will this exempt me from FIRPTA? • When a Nonresident makes a 6013(g) election to file jointly with their US spouse, they are agreeing to be taxes as a US tax resident. • Reg §1.897-9T – Resident alien individuals includes nonresident alien who has elected to be resident under Code sec 6013(g). Does the IRC 121 Exclusion apply to Non-Residents? • IRC 121 allows an individual taxpayer to exclude up to $250,000 (or $500,000 if married) of gain if they lived in Primary Residence for two out of the last five years.

16. Nonresident individual – Transfer Taxes • Estate Tax: • -Nonresident individuals subject to tax on all property located within the US • -Shares of a domestic corporation are subject to estate tax but shares of foreign corporation are not. • Some exceptions: Bank account not used in US trade or business, securities generating portfolio interest • Nonresident individuals receive a $60,000 estate tax exclusion with maximum 40% tax rate. • Gift Tax: • Nonresident normally are subject to gift tax on lifetime gifts of tangible property within the US • No specific gift tax exclusion for nonresident individuals, thought the $16,000 per donee annual exclusion is available

17. Structuring Nonresident US Real Estate Investments • Nonresident who live, work, or own property in the US need to have a clear understanding of the potential implications of the US estate and gift tax rules. • There are multiple types of ownership options available:

19. OPTION 1 – Individual ownership • Advantage • Graduated individual tax rates for rental income - 10%-37% • Long term Capital Gains tax rate 0%-20% • No Branch Tax Concern • Disadvantage • Gift / Estate Tax applies • Unlimited Personal Liability • Disclosure of ownership

20. OPTION 2 – Limited Liability Company • Advantage • Graduated individual tax rates for rental income - 10%-37% • Long term Capital Gains tax rate 0%-20% • No Branch Tax Concern • Limited Personal Liability • Personal Identity Protection • Disadvantage • Gift / Estate Tax applies

21. OPTION 3 – U.S. Corporation • Advantage • Flat Corporate tax rate of 21% • No Branch Tax Concern • Limited Personal Liability • Personal Identity Protection • No gift tax – IRC 2501(a)(2) – US situated intangible property including stock of US corp is not subject to gift tax • Disadvantage • Estate Tax applies • Capital Gain taxable as ordinary income • Double taxation - Dividend taxable

22. OPTION 4 - Foreign corporation (Not with Inheritance Tax Treaty country) • Advantage • Flat Corporate tax rate of 21% • No Gift or Estate Tax • Limited Personal Liability • Personal Identity Protection • Disadvantage • Branch Profit Tax • Capital Gain taxable as ordinary income • Double taxation - Dividend taxable

23. Why Foreign Corporation works: • The asset in the decedent’s gross estate is stock/shares in a foreign corporation. Foreign corporation stock/ shares are a foreign situated asset and are excluded from the gross estate. • BPT can be avoided with proper tax planning. BPT can be avoided if the death tax treaty (inheritance tax treaty) exists. • At present Death, tax treaties are in effect with the following countries: • Australia, Greece, Austria, Ireland, Canada, Italy, Denmark, Japan, Finland, Netherlands, France, South Africa, Germany, Switzerland, United Kingdom. • Exist the USA - Form 8848 - BPT does not apply in the year that a foreign corporation terminates all US business activities.

24. OPTION 5 – Tiered Corporate Entities • Advantage • Flat Corporate tax rate of 21% • No Estate or Gift Tax • No Branch Profit Tax • Personal Identity Protection • Disadvantage • Capital Gain taxable as ordinary income • Double taxation - Dividend taxable

25. OPTION 6 – Non Grantor Trust • Advantage • No Estate Tax • No Branch Profit Tax • Long term Capital Gains tax rate 0%-20% • Disadvantage • Give up ownership and control of assets

26. How irrevocable trust eliminates estate tax: • No assets are includable in the decedent’s gross estate. IRC 2031. • Settlor: The Settlor is the person who creates the trust by placing a particular asset that s/he owns into the trust, which are managed by trustee for the benefit of beneficiary

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