Absent proper planning, real estate purchased by a foreign investor could cost him or her millions of dollars more than the purchase price! Before a foreign investor buys real estate here in the United States, he or she should consider structuring the transaction in such a way to avoid estate and gift taxes and income taxes in connection with U.S. real estate and other assets. Generally, if a nonresident alien (an individual who is not a citizen of, and is not domiciled in, the U.S., a “foreign purchaser”) dies owning U.S. assets (like real estate or direct ownership interests in U.S. companies) that have a U.S. situs (or jurisdiction), those assets could be taxed at up to a whopping 40% rate (2014) for estate tax purposes upon the owner’s death. With simple advanced planning and structuring the asset purchases utilizing off-shore entities, a foreign purchaser can avoid U.S. estate taxes on such assets and real property. Depending on the country of residence, this same structure can also minimize U.S. income tax on the rental income and gains derived from the sale of the assets and real property.
One preferred structure to accomplish the above goals is to have the foreign purchaser establish a holding corporation outside the U.S. Preferably, this holding company should be established in the country of residency (assuming such country has an income tax treaty with the U.S. — income tax treaties generally reduce the U.S. withholding tax on dividends, royalties, rents, and other similar revenue streams). Otherwise, the holding company could be established in a country with favorable tax rules, such as the Cayman Islands, the Bahamas or Bermuda. Next, the newly established foreign holding company establishes a U.S. subsidiary through which U.S. real estate or other assets would be purchased and held. The end result is a foreign holding company being the parent corporation to U.S. subsidiaries holding assets in the U.S. — the foreign purchaser merely owns stock in the foreign holding corporation.
Upon the death of the foreign purchaser, there would be no estate tax on the real estate and other assets held by the U.S. subsidiary since the foreign purchaser only owned shares of a foreign corporation. Shares of a foreign corporation are not taxed for U.S. estate tax purposes!
If the foreign purchaser is planning on acquiring several properties in the U.S., it is advisable to purchase each property in a separate U.S. subsidiary to limit the liability of each property solely to that property and to avoid (1) U.S. income tax attributable to business operations or real estate investments in the U.S. conducted directly by foreign corporations and (2) U.S. income tax payable on the sale of U.S. real estate with respect to the proceeds that flow to the foreign parent corporation.
Further estate planning — Depending on the country of residency, a foreign purchaser should consider placing a revocable foreign trust on top of the foreign holding corporation. By placing a revocable foreign trust between himself or herself and the foreign holding corporation, a foreign purchaser can efficiently handle some of its global estate planning since the provisions of the revocable foreign trust specify what should happen to the shares of the foreign holding corporation upon the death of the foreign purchaser. The foreign purchaser should have the entire structure carefully reviewed by a U.S. tax and estate attorney to ensure that the foreign revocable trust does not have adverse U.S. tax consequences.
Timing of the establishment and funding of the legal entities is critical. The legal entities should be established and funded in the following order: the foreign revocable trust (if applicable); the foreign holding corporation; and each U.S. subsidiary, as applicable, which is eventually used to purchase the property.