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Real Estate
Going Global
United States of
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Contents
Contents
Contents ............................................................................................................................... 2
Real Estate Tax Summary United States of America...................................................... 3
Real Estate Investments United States of America ........................................................ 6
Contacts .............................................................................................................................. 34
Rental income
If a foreign person is not considered to be engaged in a US trade or business with
respect to its real estate activities, and does not elect to be so considered, that person
will be subject to withholding tax (WHT) of 30%, or a lower treaty rate, on the gross
amounts derived from the US real property.
If a foreign person is considered to be engaged in a US trade or business with respect to
its real estate activities, or elects to be so considered, it will be subject to regular tax on
its US net rental income at a maximum rate for 2012 of 35%. In the case of foreign
corporations, an additional tax of up to 30% may apply under the branch profits tax
(BPT) provisions.
Interest
Interest expense is generally deductible in calculating US net rental income. However,
deductions for interest on loans made or guaranteed by related foreign persons may be
deferred to the extent not paid, or limited if the borrower is considered thinly
capitalised. Interest paid, or in certain circumstances deemed paid, to a foreign investor
is generally subject to a 30% WHT, or a lower treaty rate. Non-contingent interest paid
on portfolio debt from a foreign lender that owns a less than 10% interest in
the borrower is not subject to US WHT.
Depreciation
Residential rental property is generally depreciable on a straight-line basis over
27.5 years. Other real property is generally depreciable on a straight-line basis over
39 years. Land improvements or other components of the property may be depreciable
over a shorter period of time. However, costs attributable to land acquisition are not
depreciable.
For 2012, for individuals, the tax rates applicable to long-term capital gains are 15% for
the amount of gain in excess of the original cost with respect to assets held for more
than 12 months, and 25% for the amount of prior depreciation taken on the property.
The 15% rate is reduced to 0% to the extent the taxpayer's taxable income is taxed at
a rate below 15%.
Generally, 10% of the gross sales price is withheld from the disposition proceeds
payable to a non-US investor, unless certain exceptions apply, or a certificate for
reduced WHT is obtained. A refund of excess WHT may be obtained.
Loss carryforward
Effectively connected losses from the operation of a US real property investment by
a foreign corporation may offset the foreign corporations income from other US
businesses or effectively connected US real estate investments. The unused operating
losses may be carried back two years, and forward 20 years.
Effectively connected capital losses of a corporation may be used only to offset
effectively connected capital gains. Unused capital losses may be carried back three
years and carried forward five years. Net losses from the sale of real property used in
a trade or business are treated as ordinary, and can offset other income.
If the REIT is owned 50% or more by US shareholders, and certain other requirements
are satisfied, a capital gain from the sale of REIT shares by a foreign shareholder will
not be subject to US tax. In addition, if a foreign shareholder owns no more than
5% of the stock in a publicly traded REIT, and certain other requirements are satisfied,
a capital gain from the sale of the REIT shares by the foreign shareholder will not be
subject to US tax.
Other taxes
A partnership that has ECI must withhold 35% of the amount of such income that is
allocated to a foreign partner. Lower rate of 15% and 25% apply to capital gains
of partners that are foreign individuals or trusts under US tax principles.
State and local income, franchise and property, and transfer taxes may also be due.
the sale or exchange of a US real estate capital asset for US tax purposes and taxed
accordingly. Generally, the Foreign Investment in Real Property Tax Act (FIRPTA)
rules requires the REIT to withhold a 35% tax on the distribution. However,
an exception to this 35% tax exists in cases where the REIT is publicly traded and
the shareholder did not hold more than 5% of the REIT during the year prior to
the distribution.
In general, proceeds from the sale of shares in a REIT regularly traded on an
established securities market by a shareholder of 5% or less for the prior five years, or
shares in a domestically controlled REIT, are exempt from US taxation. A REIT is
domestically controlled if less than 50% of the value of the REITs stock is held directly
or indirectly by foreign persons during the five-year period ending on the date
of disposition.
Offset income from one or more properties with the losses generated by others.
Transfer funds belonging to one corporation to another corporation.
The companies are jointly and severally liable for the federal income taxes.
Taxable income and gains of profitable companies in the group are offset by the tax
losses of other companies in the group.
All US corporations owned by the US holding company and meeting an
80% ownership test are required to join in filing as part of the consolidated return
group. However, with the consent of the Commissioner of the IRS, a group, may, for
good cause, be granted permission to discontinue filing as a consolidated group.
Gains or losses realised from the sale of a particular member corporations shares
are reported by the parent company, and combined with the taxable income or losses
of the other group members in the consolidated return.
Interest income and expense on loans between group members offset each other
and, therefore, are not taxed.
Taxability of intercompany gains and losses is deferred until the related asset leaves
the group.
of foreign investors from their US real estate business will normally be ECI. On
the other hand, dividend income generated from stock held in a US company that owns
US real property generally will not be considered ECI. The determination of a foreign
corporations non-ECI, and the assets that generate such income, has taken on added
significance in view of the branch profits tax, because assets included in the federal
income tax return as generating US business income may result in a BPT, if
subsequently they are disinvested, i.e. treated as non-effectively connected.
To avoid the uncertainty of the facts and circumstances test, the US tax statute as well
as some income tax treaties with the US provide for an election that a foreign investor
can make to treat its US real property investments as attributable to a US trade or
business.
Tax rates
The maximum individual and corporate regular tax rate for 2012 is 35%. For
individuals, the maximum tax rate on long-term capital gains is generally 15% or 25%
to the extent of certain prior depreciation deductions. For corporations, long-term
capital gains are taxed at the regular tax rate. Nevertheless, it continues to be necessary
for corporations to track capital gains and losses because, generally, capital losses can
be deducted only against capital gains.
The remainder of this section provides a general discussion of how the US business
taxable income from US real property is determined.
No distinction is made between the US business taxable income of foreign corporations
and foreign individuals, versus that of US citizens, residents and US corporations
because, in determining taxable income, the same rules generally apply to each. Similar
rules also apply to trusts, although some additional complexities apply that are beyond
the scope of this discussion.
A partnership is not a US taxpaying entity. Instead, the partners, whether they are
corporations, individuals or trusts, report their respective shares of partnership income
on their US income tax returns.
Special rules apply to US business income earned through direct investments by foreign
persons in a US partnership earning US business income. Under these rules,
a partnership is generally required to pay a WHT on behalf of the foreign partner equal
to 35% of the net business income allocable to the foreign partner. The withholding is
available to offset the foreign partners actual tax liability to be reported on its US tax
return. Foreign partners are permitted in certain cases to certify related losses and
deductions incurred outside the partnership, which reduce that partners tax. In
addition, the new regulations allow the 35% withholding rate to be reduced in the case
of partners who are individuals or trusts, so that the withholding rate more closely
matches the actual tax rate applicable to such income.
Interest expense
Although interest expense incurred in connection with a US real property is generally
deductible for US income tax purposes, a deduction may be deferred or completely
denied under the following circumstances:
Interest is subject to the uniform capitalisation rules discussed above.
Interest is owed at the end of the tax year by accrual basis taxpayers to related
parties that use the cash basis of accounting, including foreign parties subject to US
withholding tax on a cash basis on the interest income.
Interest is part of a passive activity loss that is not currently deductible because of
certain limitation rules.
Interest between related parties is in excess of that charged in arms length
transactions.
Interest is paid on shareholder debt of thinly capitalised corporations, and the IRS
considers the debt to be equity.
Interest is incurred on debt to carry tax-exempt investments.
The earnings stripping rules, discussed below, may apply.
The earnings stripping rules provide that a corporations deduction for interest expense
will be limited if the following conditions exist:
The corporations debt-to-equity ratio exceeds 1.5:1; and
The corporations net interest expense exceeds 50% of its adjusted taxable income;
and either:
The payee is a related person that is subject to a reduced rate of tax, or no tax, on
the interest income, e.g. where the 30% tax is reduced or eliminated because of
a treaty or the portfolio debt rules; or
The payee is an unrelated person that has obtained a guarantee from a foreign
person related to the borrower. This rule does not apply if the interest would have
been considered US business income had it been paid to the foreign guarantor.
Adjusted taxable income for this purpose is generally the taxable income of
the corporation before any deduction for interest expense, depreciation, amortisation,
depletion and any net operating loss.
If a foreign corporations only business activity is the US real property,
the determination of the amount of interest expense allowable as a deduction is fairly
straightforward, subject to rules such as those above. The deductible amount should
generally be that shown on the books and records. However, if the foreign corporation
also has assets that are not connected with a US business, then the corporations total
worldwide interest expense must be apportioned between US business income and
other income. An analysis of these rules is beyond the scope of this discussion.
The determination of interest allowable as a deduction by a foreign corporation is also
important because the excess of the interest allocable to a foreign corporations ECI,
over the amount actually paid, is subject to a 30%, or lower treaty rate, US tax.
Special rules also apply to the determination of interest expense allowable as
a deduction to non-resident aliens (NRAs). With respect to assets owned directly by
an NRA, no interest deduction is allowed to the extent it is generated by debt
that exceeds 80% of the NRAs US business assets. With respect to partnerships, if
the NRA owns less than a 10% limited partnership interest, then no interest expense
incurred directly by the NRA is allowable as a deduction. For other partnership interest
categories, special look-through rules apply that are beyond the scope of this
discussion. Interest expense directly incurred by an NRA may not be allocated to ECI
derived by a partnership and allocated to the NRA.
As previously mentioned, in 1995 the US Treasury Department issued regulations in
an attempt to prevent the use of conduit entities by foreign persons to avoid or reduce
US tax.
Depreciation
Depreciation has traditionally been one of the primary reasons why many US real
estate investments generate losses for US income tax purposes. The number of years
over which real property can be depreciated is 27.5 years for residential property, and
39 years for commercial property, including building improvements. Qualified
leasehold improvements (generally those that benefit only a specific tenant rather than
common areas) placed in service after 22 October 2004 and before 1 January2010 are
depreciated over 15 years. The straight-line method of depreciation must be used for
buildings. Personal property can be depreciated using accelerated methods and shorter
lives. Land is generally not depreciable. However, certain improvements to land may be
depreciated using accelerated methods.
Longer depreciable lives may be required when property is leased to tax-exempt
organizations or for certain specially treated property.
Foreign investment in US real estate also includes investments in natural resource
extraction, i.e. mines, oil and gas wells, and farmland. Special rules can apply
that permit the deduction of certain costs that otherwise are required to be capitalised.
The depreciation rules differ for purposes of the alternative minimum tax (AMT),
thereby possibly requiring foreign corporations to recalculate or keep track
of depreciation allowable, and the adjusted tax basis of assets under at least four
methods (the method used for books, the regular tax method, the AMT method, and
the method used for earnings and profits that is relevant for BPT purposes).
the rule requiring that instalment gains originating from years in which the foreigner
was engaged in a US business, be reported as US business income in subsequent years,
even if the taxpayer is no longer so engaged. Another critical rule requires
a 10% FIRPTA withholding tax. (See Withholding.)
Instalment sales
Nevertheless, if a foreign investor is not a dealer in real property and at least one
payment is received after the year of the sale, a proportionate amount of the gain must
be reported as the payments are collected in subsequent years, unless the taxpayer
elects out of the instalment method of reporting. There is an exception to this rule
if certain recapture provisions apply.
Because the instalment method defers the payment of the US income tax on the gain, it
has been a popular means of selling US real estate. However, the instalment method
generally cannot be used by dealers of personal property, and dealers of real property
for sales in the ordinary course of their trade or business. Certain exceptions can apply
with respect to farm property, timeshare rights and residential lots.
An instalment note receivable with respect to which a foreign seller of US real property
does not elect to report the entire sales profit and pay the FIRPTA tax in the year
of the sale, constitutes a US real property interest. Accordingly, the profit element in
each instalment payment received constitutes a taxable FIRPTA gain. If the seller
disposes of the note, then generally the entire unreported profit becomes taxable in
the year of the disposition. As a result, such foreign sellers are required to file US
income tax returns to report the FIRPTA instalment gains, even if they no longer have
any other business connection in the year the payments are received.
Special rules apply when instalment obligations are pledged as security for
the taxpayers debt, and when related parties are involved. In addition, an interest
charge on the deferred tax may be due with respect to instalment notes totalling
USD 5m or more.
Like-kind exchanges
If certain conditions are met, US real property can be exchanged with no income tax
assessed on the appreciation of the exchanged property.
These so-called 1031 exchanges do not have to be simultaneous, nor do only two
taxpayers need to be involved in the exchange. If an independent party, or
intermediary, is properly used, the taxpayers property can in effect be sold up to
180 days prior to the acquisition of the replacement property in a deferred exchange.
It is also possible, through the proper use of an accommodation titleholder, for
the taxpayer to sell the property after the new property is acquired, in a reverse
deferred exchange. The IRS issued guidance to provide a safe-harbour for taxpayers
engaging in reverse deferred exchanges.
Generally, if consideration other than the like-kind properties involved in the exchange
is received in the exchange, the taxpayer will be taxable on the gain to the extent of boot
received. This non-qualifying exchange property could be in the form of cash, property,
or debt relieved. So-called boot netting rules could provide tax relief when both
properties in the exchange are subject to debt.
183 days or more in the US during the calendar year, will generally be considered US
residents for US income tax purposes for that calendar year, starting with the first day
of their presence in the US. US residents, like US citizens, are taxed on all their income,
both business and non-business, from all sources, both US and foreign, on a net basis.
The 30% WHT on gross income does not apply to them. Accordingly, all capital gains
from sales after the individual is considered a US resident will be subject to the regular
US income tax.
Gains from the sale of US real property interests are not subject to 30% tax, because
they are always taxable under FIRPTA as US business income, irrespective of
the number of days the foreigner spends in the US. Interest income earned by
a foreigner on US bank deposits is also generally exempt from the 30% tax. However, as
mentioned previously, if the interest qualifies as US business income, it would be
subject to the regular net basis tax. US-sourced interest paid to foreigners that qualifies
as portfolio interest is also exempt from the 30% tax. Generally, to qualify for this
exemption, the interest must be paid on obligations issued after 18 July 1984, which
meet a series of requirements to help assure it is not being paid on obligations held for
the benefit of US persons.
Failure to withhold the tax on these payments makes the payer liable for the tax and
possible penalties.
Special rules
Portfolio interest exemption
The Tax Reform Act of 1984 eliminated the 30% US WHT imposed on foreign persons
on interest qualifying as portfolio interest. The Act also exempted the portfolio interest
obligations from US estate tax. Accordingly, if foreign investors, using their own
money, can finance US real property and business acquisitions with portfolio interestbearing debt, they can achieve the following tax objectives.
The interest paid by the US real property business will be exempt from US WHT.
The portfolio debt instruments held by the foreign investors or their entities will be
exempt from US estate and gift taxes.
The interest payments will be deductible by the US business and, therefore, will
shelter the propertys operating income or gain upon disposition. The deductibility
of the interest payments may be limited and deferred under either the passive
activity loss rules or the earnings stripping rules.
Foreign investors may find it difficult to structure internal financing to qualify for
the portfolio interest exemption. The reason is that portfolio interest does not include
interest received by a shareholder or partner owning directly, indirectly, or
constructively, 10% or more of the voting interests in a corporation or 10% of
the capital or profits of a partnership paying the interest. However, a planning
opportunity is available in which the foreign shareholders hold only non-voting stock,
while all of the voting stock is held by US shareholders or others not requiring
the portfolio debt exemption (such as less-than-10% foreign shareholders). If
the 10% ownership hurdle can be overcome, then the rest of the requirements to qualify
for the exemption can be met by privately issued debt, as well as publicly issued debt,
if the debt is properly structured. With respect to partnerships, the 10% ownership test
is applied at the partner level.
The portfolio interest exemption will also not apply to the following:
Interest received by a bank with respect to credit extended in the ordinary course of
its trade or business.
Interest received by a controlled foreign corporation from a related party.
Interest that is contingent on the borrowers profits, receipts, cash flow, or property
values.
Other general requirements and restrictions, according to the type of debt, are
summarised below.
Either turning in the old instrument and reissuing it to the new holder, or by
issuing to the new holder a new instrument that substitutes for the old
instrument;
Turning in and reissuing the old instrument as described above, and also using
a book entry method as described above.
Registered form debt is debt that meets the second condition above, including
the transferability requirements mentioned. The regulations cover what constitutes
registered as to principal and interest, and what is an acceptable book entry system.
The statement required of the obligation owner must be made under penalties
of perjury, and must also include the name and address of the beneficial owner.
However, procedures exist for allowing certain financial institutions to be
the registered owners of the obligations as agents for the foreign beneficial owner, so
the anonymity of the owner is maintained, and the requirements are met.
The debt obligations have a legend on them stating that any person holding them
will be subject to US tax law limitations.
For purposes of these rules, the place of payment is generally where the payer or
middleman completes the actions necessary to effect payment. If the interest payment
is made from a US account to a US address, the payment will not be considered made
outside the US. The regulations provide additional details regarding these
requirements.
The at-risk rules generally limit the losses that an effected investor can use to
the amount that the taxpayer has at-risk in the investment, which includes
the investors share of any qualified non-recourse debt that is secured by real property.
The passive activity loss rules generally provide that losses from passive activities can
offset only income from other passive activities, or gains from the sale or disposition of
these activities.
A passive activity is any for-profit or business activity in which the taxpayer or its
majority shareholders do not participate materially, i.e. regularly, continuously and
substantially. However, rental activities and limited partnership investments are always
considered passive activities with respect to the investor, unless the investor is
an individual or closely held corporation that meets strict requirements to be
considered to be in a real property business. To be so considered, an individual must
spend more than 750 hours per year working on real estate activities, and this time
must constitute more than half of the individuals work activities. A closely held
corporation is considered to be in a real property business if more than half of its gross
receipts for a taxable year are derived from real property trades or businesses in which
it materially participates. For this purpose, activities of the companys employees will
be taken into account only if an employee owns at least 5% of the company.
A special relief provision applies to certain individual investors and permits them to
offset up to USD 25,000 of non-passive activity income with losses from rental real
estate under the following conditions:
If they own at least 10% of the property.
BLIT, in turn, has two parts, which are BLIT based on interest paid, and BLIT based on
deductible interest in excess of the amount paid, or excess interest.
The following is a discussion of rules pertaining to BLT. Some points mentioned below
were explained in the early sections regarding planning, and are mentioned again
because of their significance to the entire BLT scheme.
Mechanics of BPT
The mechanics of BPT can be difficult to follow. The annual calculation of a foreign
corporations US business earnings considered repatriated for a tax year, also called
the dividend equivalent amount (DEA), can be summarised as follows:
DEA, multiplied by the 30% BPT rate, results in the BPT payable.
Conversely, E&P repatriated are assumed to be distributed first out of current year
E&P. Therefore, if US assets are repatriated during the year, i.e. no longer used in
the US business, and there is positive E&P for the year, BPT will result, even if
cumulatively the foreign corporation has E&P deficits.
A foreign corporation will not be subject to the BPT on the repatriation of its cash after
it has sold all its US real estate and other US business assets if it completely terminates
its interest in US business assets and does not reinvest those assets in a US trade or
business within three years. This result is the same as that which would apply had
the foreign investor used a US corporation to hold the US business, and had liquidated
the US corporation after it sold its assets.
Original issue discount (OID) on obligations maturing in 183 days or less from
the original date of issue.
The 30% US tax on interest paid should be withheld by the foreign corporation, and
remitted to the IRS, under the normal withholding and remittance procedures, because
the tax on interest paid is considered imposed on the beneficial owner of the interest.
To meet the stock value test, the corporation must be able to substantiate the residence
status of the shareholders in accordance with regulations.
Failure to disclose a treaty position can subject the taxpayer to a USD 1,000 IRS
penalty, or USD 10,000 in the case of regular corporations.
FIRPTA
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) and its regulations,
which subject a foreign investor to US tax on a disposition of an investment in US real
property, eliminated almost all viable means for foreigners to avoid US income tax
permanently on these dispositions.
The FIRPTA rules contain two separate and distinct aspects. The first is the substantive
aspect, which taxes NRAs and foreign corporations on the disposition of a US real
property interest (USRPI). Gain or loss realised by a foreign person from
the disposition of a USRPI is automatically considered US business income,
irrespective of whether the foreign person is doing business in the US. The second
aspect of FIRPTA is the withholding and reporting requirements.
Taxing provisions
A USRPI includes not only a direct interest in real property located in the US or
the Virgin Islands, including any pro rata interest held through a partnership, trust or
estate, but also an interest in stock in a US corporation that is a US real property
holding corporation (USRPHC).
Basically, for a corporation to qualify as a USRPHC, USRPIs must constitute at least
50% of the fair market value of its assets. A corporations fair market value generally
does not include the value of assets not used or held for use in a business, although
USRPIs and foreign real property are always includable. An alternative test based on
25% of book value of specified assets is also permitted by the regulations.
Despite the fact that a US corporation, or one treated as such, meets the 50% asset
criteria for status as a USRPHC, the FIRPTA tax will not apply to the sale of shares
of any class of the corporations stock that is regularly traded on an established
securities market if the seller owns, directly or indirectly, 5% or less of such class
of stock. This exception for stock traded on an established securities market applies
only if the 5% test is satisfied at all times during the five-year period ending on the date
of the disposition of the stock.
Real property
The term real property includes land and unsevered natural products of the land, e.g.
crops, timber, mines, wells, or other natural deposits, as well as improvements on land,
including buildings, bridges, railroad tracks, pipelines, storage tanks and bins, and
permanently installed telephone and television cables. Also included is certain personal
property associated with the use of the real property, e.g. furnishings or moveable
walls. However, despite this general rule, personal property will be associated with, and
therefore will also be considered real property for, FIRPTA purposes, only
if the personal property is predominantly used in one or more of the following four
activities:
The exploitation of unsevered natural products from the land, such as in mining,
forestry and farming activities. Equipment used to transport the products once they
are severed is explicitly excluded from association with real property.
The construction or making of improvements to the land.
The FIRPTA rules provide that interests in US real property and in US corporations
that qualify as USRPHCs that are held other than solely as a creditor will qualify as
USRPIs for FIRPTA purposes, and thereby be subject to US tax upon their dispositions.
The rules are broad enough to help assure that such interests in US real estate do not
escape taxation. The following are examples from the regulations that will generally
qualify as interests in US real property held other than as a creditor:
Fee ownership or co-ownership in US real property.
A time-sharing interest in US real property.
Direct or indirect rights to share in the appreciation in the value, or in the gross or
net proceeds, or profits generated by the US real property, or the US real property
entity.
A right to receive instalments or deferred payments from the sale of a USRPI, unless
the seller elects not to have the instalment method of reporting apply, any gain or
loss is reported in the tax year of the sale, and all tax due is timely paid.
An option, a contract or a right of first refusal to acquire any interest in US real
property, other than an interest held solely as a creditor.
An interest as a beneficiary in a trust or estate that holds USRPIs.
An interest in a partnership that holds US real property.
Leaseholds of US real property and options to acquire such leaseholds are also
classified as USRPIs.
Other provisions
Double taxation
The law provides that, except for gain from the disposition of interests in real property
located in the Virgin Islands, gain from the disposition of a USRPI is US-source
income. Therefore, a foreigner disposing of such an interest will generally not obtain
a US credit for foreign taxes, if any, imposed on the gain. In other words, double
taxation of the gain could result if the foreign investors country of citizenship or
residence does not allow a credit, or some other form of relief, for the US taxes imposed
by FIRPTA. In some cases, tax treaties will mitigate the potential double taxation.
The election provides these results because it causes the foreign corporation to be
treated as a domestic corporation for purposes of the FIRPTA taxing, withholding and
reporting provisions. Accordingly, those rules in FIRPTA applying exclusively to
foreign corporations become inapplicable to the electing corporation. Some of those
rules are the anti-avoidance rules, discussed previously, that trigger FIRPTA gain in
seemingly non-taxable transactions. However, upon making an i election, the stock
of the foreign USRPHC will be treated as the stock of a domestic USRPHC and,
accordingly, as a USRPI taxable upon its disposition.
Under the regulations, a valid i election may be made only if the foreign corporation,
as well as each person holding an interest in the corporation, e.g. shareholder, on
the date the election is made, signs a consent to the election and a waiver of treaty
benefits and the corporation is entitled to non-discriminatory treatment under
the pertinent treaty. More specifically, the law requires that tax, including accrued
interest, be paid on all previous dispositions of the companys stock, even if such
dispositions were non-taxable pursuant to a treaty. The regulations permit the electing
corporation to retain the shareholder consents in its files rather than submit them
to the IRS if certain conditions are met. Accordingly, the identities of the shareholders,
or interest holders, will not necessarily be disclosed to the IRS. Nonetheless, examining
IRS agents will have access to such consents if they believe it necessary to carry out
an examination. Therefore, absolute shareholder anonymity cannot be assured.
The regulations also require that the foreign corporation be a USRPHC, i.e. have 50%
or more of its assets, by value, in the form of USRPIs.
The regulations detail the manner, form and timing of making an election under
Internal Revenue Code Section 897(i).
Withholding tax
The general rule is that any person who acquires a USRPI from a foreign person
is required to withhold tax equal to 10% of the amount realised, and remit the withheld
amount to the IRS by the 20th day after the date of transfer. However, if the seller's
maximum tax liability is less than 10% of the amount realised, a procedure is available
to reduce the amount withheld by the buyer and/or remitted to the IRS.
Through a so-called withholding certificate application, the seller can request approval
from the IRS of the sellers representation of a calculation of the maximum tax liability
that may be imposed on the disposition of the real property, or a statement as to why
the disposition is not subject to tax.
If the withholding certificate has been filed with and approved by the IRS on
the transfer date, then the buyer or transferee can withhold a reduced amount of tax
in accordance with the approved withholding certificate, and remit the reduced amount
to the IRS.
If the withholding certificate application is pending with the IRS on the transfer date,
then the buyer or transferee must withhold 10% of the proceeds, but can wait to remit
the withheld amount to the IRS, pending IRS action on the application. The amount
withheld or a lesser amount based on the IRS determination with respect to the
application must be remitted to the IRS by the 20th day after the IRS determination.
Any amount withheld but not required to be remitted to the IRS would then be
returned to the seller or transferor.
A foreign seller may request a refund of any amounts withheld under this provision
in excess of the maximum US tax liability. The foreign seller may request the refund
prior to filing a federal income tax return; however, no interest will accrue on
the refund. In addition, the foreign seller must still file a US income tax return to report
the gain from the sale.
Buyers that fail to carry out the tax withholding become liable for the underwithheld
amount themselves if the seller fails to pay in the tax with its US return. Penalties and
interest may also apply.
The 10% withholding rule can create difficulties, because the regulations require that
the entire amount be withheld and remitted to the IRS by the 20th day after the date
of the sale, regardless of the amount actually paid by the buyer. As a result, there could
be situations, such as in an instalment sale, in which not enough of the total contract
price is paid in the initial year to satisfy the withholding requirement. In such cases,
buyers have the choice of obtaining a withholding certificate, if they anticipated
the problem in adequate time, or paying over to the IRS the required 10%, and reducing
their future instalments to the seller.
The following exemptions, inter alia, relieve the purchaser from the obligation to
withhold, but do not relieve the foreign seller of liability for the tax:
The seller or transferor furnishes the purchaser or transferee with a certificate to
the effect that the transferor is not a foreign person.
The buyer or transferee determines that the property acquired is not a USRPI. If
the property acquired represents shares in a domestic corporation that is not
publicly traded, the transferee must obtain a statement from the transferor certifying
that the stock is not a USRPI. In general, this means that the corporation must not
have been a USRPHC during the five-year look-back period discussed previously.
The transferee is an individual and acquires realty for use as a residence, not
necessarily a principal residence, at a price of no more than USD 300,000.
The transferor has made a valid Internal Revenue Code Section 897(i) election to be
treated as a domestic corporation, and furnishes an acknowledgement of the election
from the IRS to the transferee.
A domestic partnership must withhold 35% (or 15% or 25% for capital gains allocable to
individuals or trusts) of any amount over which the partnership has custody, and that is
attributable to the disposition of a USRPI or ECI, if the amounts are includable in
the income of a foreign partner.
A trustee of a domestic trust, or an executor of a domestic estate, must withhold
35% (or 15% or 25% for capital gains allocable to other individuals or trusts) of any
amount over which the entity has custody, and that is attributable to the disposition
of a USRPI if the amounts are includable in the income of a foreign beneficiary of
the trust/estate, or the foreign grantor in the case of a grantor trust. In addition, gains
from certain distributions by foreign corporations that are taxable under FIRPTA may
be subject to withholding at 35% of the excess of the fair market value of the interest
distributed over its adjusted basis. Return of capital distributions by a USRPHC to its
foreign shareholder may be subject to a 10% WHT.
Any transferee acquiring a USRPI from a foreign person is a withholding agent, and is
obligated to withhold, unless the transaction is otherwise exempt. Also, agents of
the transferee or transferor may have the liability for WHT if they fail to comply with
certain requirements. For example, a transferors agent must notify the transferee if
the transferor is a foreign corporation. Failure to do so may shift the withholding
obligation to the agent, limited to the amount of compensation received by the agent.
Estate taxation
The estate of a non-resident alien decedent is subject to US estate tax on all property
tangible and intangible situated in the US at death. Shares of a US corporation are
subject to the estate tax, whereas shares in a foreign corporation are not, irrespective
of where the corporations assets may be situated.
The estates of NRA decedents are subject to the same US estate tax rates that apply to
estates of US citizens. The rate is currently at 35%, with it set to increase in 2013 to
55%.Although the estate of a US citizen is entitled to a credit equivalent to an
exemption of USD 5,000,000 from US estate tax, the estate of an NRA is entitled to
a credit equivalent to only a USD 60,000 exemption, assuming no treaty benefits apply.
Not all people who are US residents for income tax purposes are US residents for estate
and gift tax purposes. These high rates and the low exemption amount make planning
for avoiding the estate tax an important aspect of tax planning for foreign investment
in the US real property.
Taxable gifts are included in the estate, and can, as a result, increase the rate of tax.
Credits are allowed for gift taxes paid on these gifts. The estate tax liability can also be
credited, i.e. reduced, by death taxes paid to states where the taxable property has
a situs at date of death.
Contacts
Advisory
Mitch Roschelle
Tel: +1 (646) 471 8070
E-mail: mitchell.m.roschelle@us.pwc.com
Assurance
Tim Conlon
Tel: +1 (646) 471 7700
E-mail: timothy.c.conlon@us.pwc.com
Seth Promisel
Tel: +1 (646) 471 7532
E-mail: seth.promisel@us.pwc.com
Tax
Kelly Nobis
Tel: +1 703 918 3104
E-mail: kelly.s.nobis@us.pwc.com
Paul Ryan
Tel: +1 (646) 471 8419
E-mail: paul.ryan@us.pwc.com
David Voss
Tel: +1 (646) 471 7462
E-mail: david.m.voss@us.pwc.com
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the
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of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on
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