Foreign investment in U.S. real estate.

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Foreign investment in U.S. real estate.

  1. 1. FOREIGN INVESTMENT IN U.S. REAL ESTATE Presented to State Bar of California | Tax Section April 2, 2012 ROGER ROYSE, ESQ. DAVID SPENCE, ESQ. rroyse@rroyselaw.com dspence@rroyselaw.com ROYSE LAW FIRM, PC PALO ALTO | SAN FRANCISCO | LOS ANGELES www.rroyselaw.com www.royseuniversity.com TELEPHONE: 650.813.9700 | SKYPE: roger.royseIRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in thiscommunication, including any attachment to this communication, is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1)avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein.
  2. 2. OUTLINE1. Income Tax Summary - ECI2. Withholding Taxes – FDAP and FIRPTA3. Estate and Gift Taxes4. Structuring foreign investment in U.S. real estate5. Joint ventures with offshore investors6. Financing vehicles (debt vs. equity)7. Other Concerns 2
  3. 3. INCOME TAX SUMMARY - ECIEffectively Connected Income (ECI)• Income effectively connected with a U.S. trade or business – Asset use or business activities test• Rates – 10% to 35% Individual; capital gains – 15% to 35% corporate ECI or PE• Net lease property vs. active management• Partner in tax partnership• FIRPTA Gains as ECI• Treaties and “permanent establishment” 3
  4. 4. NON–ECI OR FDAPFixed, determinable, annual or periodical (FDAP) income• Activity not rising to level of trade or business• Includes rents, interest, dividends, etc• 30% withholding rate, may be reduced by treaty• Section 871(d)/882 election to pay tax on net basis – Exclusions (interest, personal property, non business)• Branch Profits• Portfolio interest• Partnership withholding 4
  5. 5. FIRPTA (SECTION 897)Foreign Investment in Real Property Tax Act of 1980 (FIRPTA)• 10% gross withholding on dispositions of a U.S. Real Property Interest or U.S. Real Property Holding Corporation (USRPHC)• USRPHC – 5 Years – 50% or more value of assets are U.S. real estate – Optional book value method (25% test) – < 50% subs – > 50% subs (look through rule) – Foreign corporations not USRPHC• Interest Solely as a creditor - Equity kickers• Disposition is deemed to be ECI• Exemptions from withholding – Affidavit of non foreign status – Stock is not a USRPHC – Non recognition transactions• Cal-FIRPTA 5
  6. 6. ESTATE AND GIFT TAX ISSUES A RIDDLE: When is a Resident not a Resident? Treas. Reg. § 20.0-1(b)(1) provides a subjective definition of “resident” for estate tax purposes:“A „resident‟ decedent is a decedent who, at the time of his death, had hisdomicile in the United States…A person acquires a domicile in a place byliving there, for even a brief period of time, with no definite present intentionof later removing therefrom. Residence without the requisite intention toremain indefinitely will not suffice to constitute domicile, nor will intention tochange domicile effect such a change unless accompanied by actual removal.” 6
  7. 7. ESTATE AND GIFT TAX ISSUES “Residence” for Estate & Gift Tax Purposes means: “DOMICILE”• It is not the same as Residence under Income Tax Rules.• It is a “facts and circumstances” test. • Does Not Require Exclusivity • May be affected by treaty provisions • Consider: Estate of Jack v. U.S. 54 Fed. Cl. 590 (2002): • At the time of death, Decedent was legally present in the U.S. on a Temporary Work Visa. • IRS claimed he was a US domiciliary, and imposed estate tax on his worldwide assets. • Taxpayer argued that the IRS’ position imputed upon the decedent an intent to break federal immigration law. • Court denied taxpayer’s summary judgment motion, holding that if the decedent was shown to have developed an intent to remain in the US indefinitely, he could be a US Domiciliary despite his temporary Visa. 7
  8. 8. ESTATE AND GIFT TAX RATESNON-U.S. DOMICILED NON-CITIZENS Applicable to U.S. Situs Property But, what about gifts or bequests to a non-citizen spouse? 8
  9. 9. QUALIFIED DOMESTIC TRUST (QDOT) The Good: Allows testamentary bequests to non-citizen spouse to qualify for the unlimited estate tax marital deduction.  Requires all income to be paid annually to spouse for life.  No person has power to distribute to anyone other than surviving spouse. The Bad: Must have a U.S. person as trustee. If QDOT assets exceed $2 million FMV then trustee/co-trustee must be a domestic corporation (in other words, a bank). The Ugly: Distributions from the QDOT in excess of annual income are subject to withholding of estate tax at the highest marginal rate.Should US Domiciliaries be making gifts to their non-citizen spouse? 9
  10. 10. ESTATE AND GIFT TAX RATESApplicable to U.S. Citizens or Domiciliaries: 10
  11. 11. INBOUND GIFT OR INHERITANCE ASSET TRANSFER ISSUES• Intangible Assets – Stocks, LLC & LP interests, patents, copyrights, etc. – General rule—intangibles are located where the giver is located.• Tangible Assets – Real estate, equipment, automobiles, jewelry, artwork, etc. – General Rule—tangible assets have situs where they are physically located.• But, what about cash, currency, bank accounts, etc.? 11
  12. 12. U.S. ESTATE AND GIFT TAX TREATMENT OF VARIOUS TYPES OF PROPERTY Owned by a Non-citizen, Non-domiciliary BEWARE! The above table reflects general rules. Actual determination of taxability can be heavily fact-specific. 12
  13. 13. COMMON ESTATE PLANNING ISSUES FOR CROSS-BORDER FAMILIES • Inbound Cash Transfers Foreign Parent – Gifts? – Loans? – Investments? Gift or Loan $ $ Investment • Transfers of Stock/LLC interests? U.S. Child Gift of Stock – U.S. Stock? Investment $ Rent – Foreign Stock? Entity (Corp. LLC, et al) Lease • Foreign Trustees & Successor Trustees – U.S. person is often preferable. Purchase $ $ Purchase • U.S. income tax issues. • U.S. reporting issues • Logistics 13
  14. 14. STRUCTURING FOREIGN INVESTMENT IN U.S. REAL ESTATE Foreign Person Ownership Through Foreign Corp.U.S. Tax System Exposure for Foreign Person YESCapital Gains Rate (15%) on Disposition NOWithholding Tax on Repatriation of Funds NO Foreign Corp.Subject to U.S. Estate Tax NO(?)Subject to U.S. Gift Tax NOBranch Profits Tax YESTax Free Sale of Entity / Asset YES 14
  15. 15. STRUCTURING FOREIGN INVESTMENT IN U.S. REAL ESTATE Foreign Person Ownership Through U.S. Corp.U.S. Tax System Exposure for Foreign Person YESCapital Gains Rate (15%) on Disposition NOWithholding Tax on Repatriation of Funds YES U.S. Corp.Subject to U.S. Estate Tax YESSubject to U.S. Gift Tax NOBranch Profits Tax NOTax Free Sale of Entity / Asset NO 15
  16. 16. STRUCTURING FOREIGN INVESTMENT IN U.S. REAL ESTATE Foreign Person Ownership Through Foreign Corp and U.S. Corp.U.S. Tax System Exposure for Foreign Person NOCapital Gains Rate (15%) on Disposition NO Foreign Corp.Withholding Tax on Repatriation of Funds NOSubject to U.S. Estate Tax NO U.S. Corp.Subject to U.S. Gift Tax NOBranch Profits Tax NOTax Free Sale of Entity / Asset YES 16
  17. 17. STRUCTURING FOREIGN INVESTMENT IN U.S. REAL ESTATE Foreign Person Direct OwnershipU.S. Tax System Exposure for Foreign Person YESCapital Gains Rate (15%) on Disposition YESWithholding Tax on Repatriation of Funds NOSubject to U.S. Estate Tax YESSubject to U.S. Gift Tax YESBranch Profits Tax NOTax Free Sale of Entity / Asset NO 17
  18. 18. STRUCTURING FOREIGN INVESTMENT IN U.S. REAL ESTATE Foreign Person Ownership Through U.S. LLC or Foreign LLCU.S. Tax System Exposure for Foreign Person YESCapital Gains Rate (15%) on Disposition YESWithholding Tax on Repatriation of Funds NO U.S.or Foreign LLCSubject to U.S. Estate Tax YES(?)Subject to U.S. Gift Tax NOBranch Profits Tax NOTax Free Sale of Entity / Asset NO 18
  19. 19. JOINT VENTURES WITH OFFSHORE INVESTORS• Single level of income tax Foreign Persons• Qualifies for 15% preferential cap gain• No gift tax• Some risk regarding estate tax Foreign LLC• Permits gifting between partners 19
  20. 20. FINANCING VEHICLES Foreign Person• Portfolio Interest Exemption• Treaty Rates of Withholding Foreign Corp. Loans U.S. Corp. 20
  21. 21. OTHER CONCERNS• Section 1031 like-kind exchange transactions – Permits tax deferral – Strict statutory requirements – U.S. property is only “like-kind” to other U.S. property, and foreign property is only “like-kind” to other foreign property 21
  22. 22. ROGER ROYSE, ESQ. DAVID SPENCE, ESQ. rroyse@rroyselaw.com dspence@rroyselaw.com PALO ALTO | SAN FRANCISCO | LOS ANGELES www.rroyselaw.com www.royseuniversity.com TELEPHONE: 650.813.9700 | SKYPE: roger.royseIRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication,including any attachment to this communication, is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding penalties 22under the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein.

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