What options exist for foreigners seeking to buy US real estate? This article drills into the details.

For all the noise – most of which isn’t particularly informative – around US politics and the talk of a supposed rollback to globalization, there remain plenty of reasons why non-US persons want to invest in the world’s largest economy, including its real estate. In this article, Kenneth P. Brier, a partner of Brier & Ganz LLP in Needham, MA, looks at some of the issues foreigners face. This news service is pleased to share these views and invites responses. Email tom.burroughes@wealthbriefing.com

In spite of the recent political commotion, the US remains a magnet for foreigners seeking a safe place to hold a piece of their wealth.  For some, a US residence also represents a potential place of refuge. So wealthy foreigners continue to invest heavily in US real estate, including second (or third or fourth) residences. Aside from ownership for oneself, it is not uncommon for wealthy foreigners to purchase a condo for a son or daughter pursuing professional or graduate, or even undergraduate, education here.

Structuring the ownership of real estate for foreigners remains a surprisingly tricky matter. Foreigners and their advisors need to take into account the complex interplay of federal and state income taxes and estate and gift taxes, as well as the laws of the foreigner’s home country.

All of this impacts the advisor’s advice on the form of ownership. That form might entail outright ownership or ownership through one or more entities, domestic or foreign, such as a corporation, LLC, partnership, or trust. For foreigners with a child who has set up residence here, sometimes the best arrangement is not to own any real estate at all, but instead to lend the purchase money to the child, perhaps secured with a mortgage.

Individual ownership standard operating procedure
Residential real estate is often purchased with the assistance of a real estate lawyer and no other advisor (and in some places without legal assistance at all, the closing being handled by a title company).

Standard operating procedure might then entail vesting title in the individual purchaser’s own name, or if married, in the purchasers’ names as joint tenants or tenants by the entirety.  But structuring a foreigner’s title on autopilot can lead to adverse results.

Holding title individually indeed poses a major problem for nonresident foreigners. Upon death, US real estate is subject to the U.S. estate tax. And for nonresident aliens, this tax is not sheltered by the same generous exemption amount, now $5.49 million, granted to US citizens and residents. Subject to possible treaty relief, they are granted the equivalent of a mere $60,000 exemption. Moreover, there are significant limitations on deductions. Again subject to possible treaty relief, those limitations include mandatory apportionment of mortgage debt between US assets (deducible) and foreign assets (non-deductible), even for a mortgage encumbering only the US residence. There is also a general disallowance of any marital deduction for property passing to a noncitizen spouse.

If the purchaser is young and healthy and expects to hold the residence for only a limited number of years, he or she might reasonably choose to keep things simple and accept exposure to the US estate tax. Coverage of that risk by life insurance might be cheaper than setting up a more complicated structure.

Ownership through a foreign corporation
In other cases, however, a well-advised foreign purchaser will avoid titling in any individual name.  Because stock in a US corporation is subject to the US estate tax on nonresident aliens (in the absence of treaty protection), the structure of choice has often been to hold a residence in a foreign corporation.  This structure serves to avoid US estate taxation, as the deceased foreign shareholder would not own any US-situs asset. But it comes at some income tax cost. When the residence is sold, the foreign corporation will be subject to a federal tax of 35 per cent on any gain, as contrasted with a maximum long-term capital gain rate of 20 per cent payable by an individual or a trust.

Foreign non-corporate entities – partnerships, LLCs, and trusts
So consideration should be given to holding the residence in a noncorporate entity. A foreign partnership or limited liability company is certainly a possibility, but these forms run into the lingering uncertainty of their treatment for US estate tax purposes, whether to be construed as a unitary foreign entity or an aggregate of ownership interests in the underlying property, which in this case would be US-situs real estate.

This leaves a foreign irrevocable trust as possibly the ideal title-holder. This suggestion is subject to some caveats, however.  If a foreigner creates the trust with the idea of occupying the trust property himself, the property will be reincluded in his or her US gross estate.  The trust would work well, however, where another person, such as a child, is designated as the beneficiary, with the rights to occupy the property.

A married donor - say, a wife - could safely name her husband as the beneficiary, and in that case, under well-settled tax principles, the husband could permit the donor-wife to use the property too, rent-free, without causing reinclusion in her gross estate. The wife’s use would be treated as a natural adjunct of the marital relationship. If the beneficiary (such as a child) is a US person, the rent-free use of the foreign trust’s property would give rise to an imputed trust distribution to the beneficiary, but that imputed distribution would be without tax consequence, as long as the trust produces no income.

The irrevocable trust would also have to mesh with the laws in the foreigner’s home country. Trusts have long received a mixed reception in civil law countries where the idea of the common-law trust historically has been quite foreign. With the increase in cross-border transactions and increased familiarity with trusts, as well as the adoption of the Hague Convention on Trusts by several key nations, legal recognition of trusts is a lesser problem than it used to be.  Many countries, however, still characterize trusts unfavorably under their own tax laws, even if they do otherwise recognize them.

First-purchase principle
For the foreign trust arrangement to work, it is essential that the trustees serve as the original purchasers of the residence. Once the foreigner owns it, it is not possible to transfer it into a trust without an unfavorable gift tax or income tax result.

The first-purchase principle applies also to the foreign corporation alternative. Here the problem is the potential triggering of gain upon the later transfer to the corporation. If transferred soon after purchase, the property may have accrued little or no gain.  In general, however, once the property is owned in the foreigner’s own name, it is often impossible to fix the arrangement without triggering some US tax. 

Mortgage loan alternative
In some cases, the easiest way for a foreigner to avoid a US tax issue is to avoid owning any US property at all, either directly or indirectly. For example, if the foreigner wants to buy a residence for a child who is US resident or citizen, it might make sense for the child to buy the property in his or her own name. If the parent does not want to give the child the money to make the purchase, he or she might lend it instead, perhaps taking back a mortgage. The mortgage will not be treated as US-situs property for estate tax purposes. However, the parent would not share in any appreciation in the value of the property, and for income tax purposes the payment of interest on the note would attract a withholding tax, generally at 30 per cent.

About the author: Kenneth P. Brier is a partner of Brier & Ganz LLP in Needham, MA.  His practice focuses on tax and estate planning and wealth preservation matters.