Real Estate Ownership in the U.S. by a foreign investor

Issues and Planning

US Withholding and Reporting

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Withholding Tax

Certain types of U.S. source income are subject to gross basis taxation by the U.S. when earned by foreign companies or nonresident aliens

• Tax is collected through a withholding mechanism and is generally 30% for fixed or determinable annual or periodic income (FDAP)

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Withholding Tax

Items that qualify as FDAP:

• Dividends

• Interest

• Rent

• Royalties

• Salaries and Wages

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Withholding Tax

Income that is exempt from withholding:

• Interest from bank deposits, certain OID, portfolio interest

• Dividends from 80/20 companies• Capital Gain, unless it relates to US real property• Compensation for services performed outside the U.S.• Income effectively connected with a U.S. trade or

business (but the NRA becomes liable to file U.S. Taxes – other issues must be considered)

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Withholding Tax

Withholding Obligations

• The payor of items potentially subject to withholding (withholding agent) must determine if they have any withholding obligation.

• The foreign payee (taxpayer) must provide the documentation necessary to determine the correct amount of withholding tax.

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Withholding Tax

Withholding Obligations

• A withholding agent is any person having control of an item of income (such as FDAP) of a foreign person subject to withholding

• A withholding agent is obligated to withhold a U.S. tax of 30% on payments subject to withholding (or lower treaty rate where applicable)

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Withholding Tax

Withholding Obligations

A withholding agent can withhold at less than 30%, as appropriate if he/she can reliably associate a payment with valid documentation that provides the recipient is either a U.S. person or a foreign person subject to reduced rate of withholding under a tax treaty with the U.S.

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Withholding Tax

A Valid Withholding Certificate meets the following conditions:

• Made on a fully complete and signed Form W-8• Made while a Form W-8 is still valid• Is received prior to making the payment• The IRS has not notified the withholding agent that the

Withholding Certificate information is incorrect or unreliable

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Withholding Tax

Forms W-8 (Withholding Certificates)

W-8BEN – certifies foreign status of the beneficial owner of a payment (may require ITIN if treaty benefits desired)

W-8ECI – certifies that payments are treated as effectively connected with a U.S. trade or business and are exempt from withholding

W-8EXP – certifies status as certain types of foreign tax exempt entities (governments, international organizations, central banks, etc.)

W-8IMY – certifies status as an intermediary between the withholding agent and the beneficial owners

Withholding Tax

Withholding Agent’s Filing Responsibilities

• Form 1042-S – individual reporting for each payee, income category, withholding tax rate, exemption code (if any); equivalent to Form 1099 series for domestic payees

• Form 1042 – Annual Withholding Tax Return• A Qualified Intermediary may create pools for all beneficial owners

within the same income and withholding tax rate category (preserving investor anonymity)

Withholding Tax

Special Withholding Regimes• FIRPTA Withholding – typically 10% of amount realized

upon disposition of a U.S. real property interest by a foreign person

• Partnership Withholding on foreign partner’s share of effectively connected income (35%)

• Reduced withholding possible where withholding certificates are obtained

• Foreign taxpayer files U.S. tax return.

Foreign Investment in Real Property Tax Act

“FIRPTA”

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FIRPTA

General discussion• The FIRPTA rules generally prevent the tax-

free sale of U.S. real property by foreign owners

• FIRPTA was enacted in 1980 in light of concerns about the ability of foreigners to avoid US tax on real estate gains

• The intention of FIRPTA was to establish equitable treatment for foreign and domestic investors in U.S. real property

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FIRPTA

General Rule

Under IRC § 897, the general rule is that the gain or loss from the sale of a U.S. Real Property Interest by a foreign corporation or non-resident alien is treated as effectively connected income with the conduct of a trade or business and therefore subject to US income tax

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FIRPTA

What is a U.S. Real Property Interest (USRPI)?• (1) Any interest, other than solely as a creditor, in real

property located in the U.S. (or U.S. Virgin Islands),

AND• (2) Any interest, other than solely as a creditor, in a

domestic corporation UNLESS it is established that the domestic corporation is not a U.S. Real Property Holding Company (USRPHC)

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FIRPTA

Ownership interests in property may include:

• Leaseholds

• Life Estate

• Right to share in appreciation of value

• Options

• Installment obligations (unless taxpayer elects out of installment treatment)

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FIRPTA

Ownership interests in property may exclude:

• Interest in real property solely as a creditor

• 5% or lower interest in a publicly traded company

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FIRPTA

Real property may include:• Land• Buildings and various improvements• Personal property associated with real

property e.g., hotel furnishings, furnishings connected

with rental of office space, property used in farming or mining

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FIRPTA

US Real Property Holding Company (USRPHC)• A U.S. or foreign company qualifies as a USRPHC

if the following fraction is 50% or more on any testing date: FMV of USRPIs, OVER FMV of USRPIs + FMV of foreign real property +

assets held/used in the taxpayer’s trade or business• This test is conducted over a five-year testing

period

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FIRPTA

USRPHC• Assets held/used in a trade or business may include:

Cash and securities Inventory Depreciable trade or business property Goodwill and other intangibles

• The above assets must be held or used in the taxpayer’s business and must satisfy the requirements of Reg. § 1.897-1(f) to be included in the USRPHC analysis

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FIRPTA

USRPHC Subsidiaries

If a company holds a controlling interest in another corporation, the parent is treated as owning a proportionate share of the subsidiaries assets for purposes of determining whether the parent is a USRPHC

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FIRPTA

USRPHC Determination Dates

• Date USRPI is acquired

• Last day of taxpayer’s tax year

• Date non-U.S. real property is disposed of

• Date trade or business assets are disposed of

• Alternative monthly determination dates

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FIRPTA

USRPHC Status• Once a domestic corporation is classified as a USRPHC,

any interest in the corporation is treated as a USRPI for the five year period after that date. Exception - where all USRPIs have been sold by the

company in transactions where the full amount of realized gain is recognized (Cleansing rule of 897(c)(1)(A))

• The following are not USRPI; “Domestically controlled” real estate investment trusts A 5% owner of publicly traded interests in public companies A 5% percent owner of interests in public companies that

are not regularly traded

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FIRPTA

USRPHC Presumption• It is presumed that a domestic company is a USRPHC unless

established otherwise by: The domestic company certifies that is has not been a

USRPHC during the five-year period ending on the date of the transaction by providing a non-USRPHC statement; or

Requesting the IRS to determine USRPHC status

• A non-USRPHC statement must be obtained by a foreign shareholder in order to avoid withholding on the disposition of an interest in the domestic company

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FIRPTA

What is the impact of USRPHC status?• Withholding 10% of the proceeds is required

on the transfer of an interest in a USRPI by a foreign person under IRC § 1445(a)

• If a U.S. partnership disposes of a USRPI then the partnership is required to withhold the applicable amount that is allocable to the foreign partners (IRC § 1446, Treas. Reg. § 1.1445-5(c)(1)(ii)

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FIRPTA

• Other exceptions Personal residence sale of $300,000 or less

(IRC § 1445(b)(5)) Transaction is eligible for non-recognition and

proper notice is provided to transferee and IRS (Treas. Reg. 1.1445-2(d)(2))

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FIRPTA

• New Developments - Reasonable Cause Relief Prior to June 27, 2008, taxpayers had to request a private

letter ruling under Regs. § 301.9100-3 (“9100 relief”) to seek relief for late FIRPTA filings

Under Rev. Proc. 2008-27 there is a new application procedure for relief for the failure to withhold without going through the 9100 relief process

The Rev. Proc. requires that the taxpayer file a completed statement or notice when it becomes aware of the failure to file the required statements or notices and explain how the taxpayer’s failure to timely file was due to reasonable cause

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FIRPTA

• New Developments - Reasonable Cause Relief Upon receipt of an application, the IRS will decide if the

requirements for granting relief under the Rev. Proc. have been met

The IRS will notify the taxpayer in writing within 120 days if it determines that the failure to comply with the withholding requirements under FIRPTA were not due to reasonable cause, or if additional time is needed to make a determination

The taxpayer can still seek 9100 relief, but only if relief has been denied under the under the Rev. Proc.

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FIRPTA

FIRPTA Planning

• Upfront structuring Use of Blocker corporation Domestically Controlled REIT Equity / debt structuring

U.S. Gift and Estate Tax Considerations Regarding Inbound

Investments

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U.S. Estate and Gift Tax Residence Rules

• Domicile is key in addressing U.S. estate and gift taxation.• Residency for U.S. income tax purposes is not the same as

Domiciliary for U.S. gift and estate tax purposes. Substantial Presence Test – objective test; Concept of Domicile – subjective test based on facts and

circumstances.

• Estate Tax Treaties – Income Tax Treaties.• It is possible to be a U.S. income tax resident but not a

domiciliary for U.S. gift and estate tax purposes.

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U.S. Estate Taxation

• Non-Domiciliary subject to U.S. estate tax on the transfer of the gross estate situated in the United States:

U.S. real estate; Tangible property situated in the United States (both tangible and

intangible).

• Non-Domiciliary’s estate tax exclusion is only $60,000, as opposed to a U.S. domiciliary which is $3,500,000.

• Marital deduction allowed only if the donee spouse is a U.S. citizen. Qualified Domestic Trust may provide relief.

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U.S. Gift Taxation

• Non-Domiciliary subject to U.S. gift tax on the transfer of U.S. situs property:

U.S. real estate; Tangible property situated in the United States; Currency is defined as tangible property so (i.e. cash held in a U.S. bank

account).

• However, transfers of intangible personal property are expressly excluded from gift tax.

• Non-Domiciliary allowed the $13,000 annual exclusion per donee.

• Marital deduction allowed only if the donee spouse is a U.S. citizen. In such case, an annual exclusion of $133,000 applies for gifts to such non-citizen spouse.

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Individual Ownership

Non Resident Alien/Domiciliary

U.S. Real Estate

• Simple manner to own real estate.

• NRAD benefits from lower individual Capital Gains tax rate.

• However, NRAD subject to U.S. estate tax upon death. NRAD also subject to U.S. gift tax on transfer during life.

• NRAD subject to liability from creditor claims arising from direct ownership.

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Ownership Through U.S. Corporation

Non Resident Alien/Domiciliary

U.S. Real Estate

• NRAD benefits from lower individual Capital Gains tax rate on sale of USCo. However, USCo does not enjoy lower capital gains rate on sale of U.S. Real Estate.

• NRAD subject to U.S. estate tax on value of USCo upon death.

• NRAD not subject to U.S. gift tax on transfer of USCo during life.

• Provides limited liability to NRAD.

USCo

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Ownership Through Foreign Corporation

Non Resident Alien/Domiciliary

U.S. Real Estate

• NRAD not subject to income tax on sale of ForeignCo. However, ForeignCo does not enjoy lower capital gains rate on sale of U.S. Real Estate.

• NRAD not subject to U.S. estate tax on upon death.

• NRAD not subject to U.S. gift tax on transfer of ForeignCo during life.

• Provides limited liability to NRAD.

ForeignCo

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Ownership through double tiered structure and potentially a foreign trust or private foundation

NRA / Trust / Private Foundation •ForeignCo shares are not FIRPTA asset and disposition escapes U.S. taxes as long as NRA remains the owner.•There is no Estate and Gift Tax exposure for the NRA in the U.S..•The trust or private foundation works as a pre-immigration planning tool, as well as a living disposition in the event of succession. •The Private Foundation (equivalent to a trust for the U.S.) also serves Estate taxes planning purposes for jurisdictions like Venezuela. U.S Real estate

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Ownership Through Foreign Partnership

Non Resident Alien/Domiciliary

U.S. Real Estate

• Some practitioners believe an interest in a double tiered partnership structure is not US situs property for estate tax purposes.

• The Internal Revenue Service does not agree with this position, but the issue has not been resolved by the courts.

• Preserves capital gains lower rate of taxation.

For.

U.S.

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Pre-Immigration Planning

• Pre-Immigration Income Tax Planning Postpone residency starting date Accelerate income; Sell income producing property; Effectuate taxable reorganizations; Make “check-the-box” elections on entities to accelerate gains and

step up basis in underlying assets.

• Pre-Immigration Estate/Gift Tax Planning Accelerate gifts of non-situs US property and intangible property. Use of foreign trusts (care regarding creation within 5 years of

residency).

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Circular 230 Disclosure

• To ensure compliance with Treasury Department regulations, we wish to inform you that, unless expressly stated otherwise in this communication (including any attachments) any tax advice that may be contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.