10 Tax Tips for Foreign Real Estate Investors
1. Renting is a passive activity. If you are renting out a property in the U.S., the first thing you need to know is that according to the general rule of the tax code, related to rental activities, they are considered passive, which means that the taxpayer does not materially participate in them. Of course, there are exceptions to this rule for real estate professionals, but proving that your activity is not passive could be a quite complicated procedure. We have previously discussed that in an another article, which you can see here. If your rental activities are categorized as passive, so is any income you receive from them. If you end up at a loss from those activities, you can only offset that loss if there is a passive income, otherwise, you will have to carry your loss to the next tax year without an expiration.
2. Cash Basis. The rental income is calculated on cash basis and includes the following:
- Received rent
- Prepaid rent
- Repairs or maintenance activity performed in lieu of receipts
- Expenses, related to the rental business activity
- Depreciation rates
3. Tax Withholdings. Foreign nonresidents who own as individuals and rent out properties in the U.S. are usually subjected to a 30% withholding of their income from rent collected. However, there are ways in which those individuals can take full advantage of the allowed and applicable deductions, and therefore pay less tax on their rental income to the IRS. The best approach to this would be an election to consider rental income as effectively related to the performance of a trade or business within the United States. This, though, will have to be reported on the annual tax report of the individual in the country of their residence as part of their worldwide income. Each country has their specific rules and forms that apply to such cases.
4. Tax Treaties. The United States has signed tax treaties in various countries around the world to avoid double taxation of foreign individuals who do business in the U.S. So, often times, some taxes you have paid in the U.S. as a non-resident can be deducted from your tax liabilities to your country of residence. Please be aware that this is not a 100% rule and you should consult your Accountant or CPA about your particular case.
5. Sales Price. Another situation in which there are serious tax implications is when a non-resident sells a property in the U.S. Very often capital gains are generated if the sale price is higher than the tax basis of the property.
Sale price is made up of any payment received in:
- Kind, or
- Debt assigned to the buyer
Tax basis includes:
- The price of acquisition of the property
- Improvements or renovations, and
- Depreciation allowed
6. Capital Gains. The rates at which Capital Gains are taxed depend on how long the individual has owned the property before they sold it. In the case where a taxpayer has been the owner of the property for more than a year, any Capital Gains resulted from the sale are taxed at preferred rates, which can be 0%, 15% or 20%, depending on the taxpayer’s overall income. If the property has been owned by the seller for a period of one year or less, then the Capital Gains are treated like ordinary income and they are taxed at ordinary income rates, falling in the bracket between 15% and 39.6%.
7. Exceptions. Although, some exceptions apply, in most cases a foreign seller will be a subject to 10% withholding of the sale price under the FIRPTA rules. This, however, can be avoided or at least decreased if certain information is provided to the IRS before the transaction was made. Some current laws allow the exclusion or delay of paying taxes on Capital Gains in particular cases, like for example, the sale of principal residence or like-kind exchanges.
8. Principal Residence. Principal residence is your primary or home address. So when you sell your home you are entitled to an exclusion of tax on Capital Gains up to $250,000 if you are single or $500,000 if you are filing a joint tax return with your spouse. This rule applies only if this has been your principal residence for at least two out of the five years preceding the sale. Those do not need to be the last two years, but any 2 365-day periods within the last 5 years.
9. Like-kind Exchange. The like-kind exchange rule applies when the seller identifies another property that is similar (or used in a similar fashion) to the one that they are selling within 45 days of the transfer. They are also required to take it into possession within 180 days of the original transfer. If these two requirements are satisfied the taxpayer will not have to pay tax on Capital Gains because the tax basis of the newly acquired property will be the same as the ones of the disposed property. However, you must be aware that any amount that you have received and not reinvested in a like-kind property will be a subject to taxation. This is to say that the like-kind exchange mechanism only provides a deferral of taxes and not complete elimination.
10. In Summary:
- Rental activities, which are passive produce a passive income. Without a passive income, a loss cannot be offset and is carried to the next tax period indefinitely.
- U.S. non-residents who rent out properties in the U.S. can decreased the amount of taxes they owe by electing to include their rental activity and income in the tax return in their country of residence.
- When selling a property in the U.S. a non-resident will have to pay taxes on Capital Gains from the sale, in addition to a withholding of 10% of the sale price.
- Capital Gains are taxed on different rates, depending on the duration of ownership before the sale
There are mechanisms, which can eliminate taxes on Capital Gains up to certain amounts or delay the payment of such taxes if particular conditions are met.
Fulton Abraham Sanchez, the founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specialized in Tax Planning. You can email him to firstname.lastname@example.org.
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