Key considerations and practical suggestions for foreign persons looking to invest in united states

Ana Carolina Wigand - Newsletter Choice

It is difficult to underestimate the appeal US real estate has for many international investors. Real estate investments can serve a multitude of attractive purposes. It can be a source of US dollar income, providing a steady flow of return on investment. It can be a storage of wealth for those who wish to secure their wealth against local currency risk and inflation. It may even serve for personal use as a summer home. It is no wonder that an estimated 20% of Florida real estate was purchased by foreign investors prior to 2020. While the socioeconomic consequences of the COVID-19 epidemic did lead to a drop in foreign inbound investment, we are starting to see a strong resurgence of interest in US brick and mortar investments among international investors.

While attractive to many internationally, US real estate investment can be expensive to people who engage in it unprepared. Careful preparation and using the right structure to conduct your investment is the key to avoiding some of the more costly pitfalls of investment.

There is no single structure that can fit the needs of every investor. Structures can prioritize privacy, asset protection, cost efficiency, or practicability. In finding the right fit a diligent investor should take into account, reporting requirements, exchange of information agreements, asset protection laws, tax costs, structure costs, and how easy the structure might make opening bank accounts or obtaining mortgages. This kind of analysis should and often does get outsourced to professionals who far too often rely on industry standard instead of taking the time to study what will best fit their client’s needs. I hope in the following pages to help those who wish to affect a plan for themselves or their clients to get an overview of some topics they might need to consider. Covering all these topics in their entirety is the subject of volumes of books and beyond the scope of this article. My hope is to elucidate on the key concepts which investors should be made aware of and examine against these concepts the five most used and useful structures for international investors looking to invest in US real estate.

Key concepts for international investors:

Types of investor entities

“Who is investing” is the first and most important question when dealing with real property investment. There is no general bar on who may purchase real property in the United States. The holder of the real property can be anyone from individuals, corporations, partnerships disregarded entities, grantor, and non- grantor trusts. The treatment of these potential investors is also heavily based on if they are foreign or domestic.

Generally, a corporation partnership or disregarded entity is considered domestic based on its place of incorporation. If they are registered in a us state they are considered domestic, if not they are generally considered foreign. Treatment as a corporation, partnership or disregarded entity is determined at the time of incorporation, or by subsequent election. Without election, Corps are taxed as C-Corporations, single member LLCs are taxed as disregarded entities, multi-member LLCs are taxed as partnerships, and almost all foreign entities are taxed as foreign corporations. The United States offers some flexibility in the tax treatment of entities through form IRS form 8832. This form allows certain domestic and foreign companies to elect their United States tax treatment. US corporations can elect to be treated as S corporations. US LLC’s can elect to be treated as C-Corporations or S-Corporations, and some foreign corporations can generally elect to be treated as partnerships or a disregarded entity. In the case of foreign corporations, it will depend on weather the foreign corporation is not on the list of pre-se corporation’s ineligible for election. Electing to change the tax status of your company usually only affects the IRS treatment of that entity and normally will have no effect on how other jurisdictions will view the company.

Trusts are a little bit more nuanced in this regard. For a trust to be considered domestic it must be governed by a US jurisdiction, the “court test”, and substantially controlled by a United States individual, the “control test”. Failing either test will result in the trust being considered a foreign trust. Some US states have passed “directed trust” statutes which allows grantors flexibility in determining the tax status of their trusts by placing substantial control of a trust’s assets in a foreign third party and not the professional trustee. When these third parties are nonresident aliens to the United States, these trusts fail the control test. In essence a trust can enjoy the benefits of the laws of Wyoming, Nevada, or South Dakota, and be considered a foreign trust for income tax purposes. We will explore the importance of these kinds of trusts below.

Foreign trust structure

The foreign trust structure is potentially one of the most protective structures in existence for real estate investments. It involves a foreign non- grantor trust owning 100% of a domestic LLC. The foreign trust will need to file a 1040NR in the name of the trust whenever there is rent or capital gains. This structure is also subject to a single tier of taxation in individual income and capital gains rates. It has the best limitation on liability, as neither grantor or beneficiaries of the trust are generally treated as owning the real property. Depending on what laws govern the trust, this could have one of the highest levels of privacy protection. It absolutely protects against the imposition of Estate and Gift taxation, and Brach Profit Tax does not apply since there is no foreign Corp or 1120F filings. It is important to note that investors using this structure still need to plan around FIRPTA and take into account that trusts tend to be more expensive to set up and maintain than other entities.

This structure is highly flexible, and I have no issues recommending it to investors. With the development of favorable directed trust laws in South Dakota, Nevada, and Wyoming, you can even have the flexibility of having a US based foreign trust. These trusts would keep the privacy and asset protection laws of those states while allowing foreign investors to keep the foreign tax treatment.

The use of partnerships

Replacing disregarded LLCs in the structures discussed above with Partnerships can offer more than a few benefits. Namely US partnerships are not subject to FIRPTA withholding. Partnership withholding is applicable, but that withholding is over net income, and more easily refunded when the foreign partner files a return. Using partnerships will add additional filing requirements, as the partnership will need to file a separate 1065, but it can help partners avoid some headaches without generating increase taxation.

Volz, João Pedro. “Key Considerations and Practical Suggestions for Foreign Persons Looking to Invest in United States Real Property.” Saint Joseph International, Saint Joseph International, 22 Aug. 2022, https://saintjosephgroup.com/en/key-considerations-and-practical-suggestions-for-foreign-persons-looking-to-invest-in-united-states-real-property/.