The U.S. real estate market continues to attract investors from around the world. People from other countries who invest in American real estate enjoy high levels of versatility and profitability that often cannot be found in other property markets elsewhere.
However, foreign real estate investors need to remember that any profits they gain from their investments are subject to taxation in the U.S. As an out-of-country investor, you can better understand and abide by American tax laws and maximize your income opportunities by utilizing our investment consulting services today at Upside Investments.
Understanding FIRPTA
Foreign investors in the American real estate market can sometimes be caught by surprise to know they must pay taxes on their U.S.-held properties. Even if they know they must pay taxes, they may not know for sure at what rate their properties will be subject to taxation.
The Foreign Investment in Real Property Tax Act, or FIRPTA, is the American law that taxes foreign real estate investors. It implements taxes at varying rates for individual investors, as well as businesses, LLCs and other entities that invest in the American real estate market.
It also ensures both rental income and proceeds from real estate sales are taxed at applicable rates. The rates for taxation on foreign-owned U.S. real estate can range from 15 to 35 percent, depending on the type of entity that owns it.
However, foreign real estate investors might minimize or avoid FIRPTA by utilizing taxation agreements between the IRS and the country in which they reside or do business. These agreements can significantly reduce the percentage at which real property that an investor owns is taxed in the U.S.
The basics of FIRPTA can be challenging for foreign investors to understand or utilize. Let us at Upside Investments help you learn more about and abide by FIRPTA for your American real estate investments.
Taxation of Rental Income
If you own and rent out American real estate, you must pay yearly taxes on your rental income. The rate at which income from foreign-owned rental properties is taxed is 30 percent.
Foreign investors have two options for paying taxes on rental income in the U.S. The first option allows you to appoint a trustee to collect your rental income, withhold the mandatory 30 percent and then pay the taxes to the IRS on your behalf. If there is an income tax treaty between the IRS and your home country, you may pay less than the standard 30 percent rate.
Your second option involves filing a tax return every year to declare your income and pay taxes on it, much the same as Americans do. To utilize this option, you must first file a W-7 to obtain a Tax Identification Number, or TIN. You must also file a Form W-8ECI, or NET Election, to designate a withholding agent for your rental properties.
Once you file those forms and obtain your TIN, you can then file a return every year and declare and pay taxes on your rental income. The second option requires a bit more paperwork. However, it allows you to take deductions related to owning and operating your rental properties, such as:
- Mortgage interest
- Advertising
- Property taxes
- Cleaning and maintenance expenses
- Property management fees
Any income you have left after paying these costs will then be subject to the standard taxation rate.
Taxes on Real Estate Property Sales
FIRPTA also requires the taxation of any money made from real estate sales or transactions. Many foreign real estate investors buy properties to flip, for example. When they fix up and sell these properties, these investors must then pay taxes on what FIRPTA labels Effectively Connected Income, or ECI.
ECI is actually defined as any income that a foreign investor makes while engaged in a business or trade within the U.S. Gains from selling real estate in the U.S. qualifies as ECI.
However, ECI can also extend to the disposition, or transfer, of American real estate. For example, if you gift real estate, transfer the title to a piece of property or pass on real estate as an inheritance to someone, you must pay taxes on it. These transactions count as ECI under the FIRPTA law.
Under FIRPTA, the IRS also taxes the sale or transfer of foreign-owned property like:
- Residential or commercial buildings
- Vehicles
- Farm equipment
- Furniture
- Stock
Even more, FIRPTA applies not only to individual foreign investors but also foreign companies.
FIRPTA and Categories of Real Estate Property Ownership
FIRPTA implements varying levels of taxation on foreign-owned U.S. real estate. These rates differ according to the type of owner of the property.
For example, a foreign individual, partnership, trust or estate that owns real estate in the U.S. typically will pay a taxation rate of 15 percent of the investment’s fair market value or sales price.
The 15 percent tax rate, however, should not exceed the actual tax liability on the property. This classification of investor can likewise apply for a reduction of real estate investment taxes using IRS Form 8288-B.
Foreign corporations can also invest in the U.S. real estate market. They will pay a standard taxation rate of 21 percent on any real estate investments they buy and own.
American partners in a U.S. partnership will not be subject to FIRPTA taxes. However, any out-of-country investors that are part of a U.S. partnership will pay 35 percent of any allocable gains paid to them.
Finally, U.S. corporations, like U.S. partnerships, that own real estate market do not pay FIRPTA taxes on their real property dispositions. However, they will pay a standard tax rate of 21 percent on any investment gains.
Understanding how FIRPTA applies to your U.S. real estate investments as an out-of-country investor can be complex, if not outright confusing. Do not risk violating this tax act and losing your real estate investments. Let us at Upside Investments help you learn about FIRPTA and how your properties will be taxed in the U.S.
