Tax Planning for Foreign
Investors in US Real Estate
Robert J. Kiggins, Esq.
McCarthy Fingar LLP
ITSAPT Conference November 8, 2012
rkiggins@mccarthyfingar.com
Disclaimer



My views and notions of relevant law are
being presented not those of McCarthy
Fingar LLP
This presentation is for informational
purposes only and is not intended as tax
or legal advice
Always seek counsel for any specific tax or
legal situation.
Why the USA?



Prices are relatively low – bargains???
Interest Rates are Attractive
But tax planning is essential
What is a Non-US Resident


Income Tax
 Individual
 Not a US Citizen
 Not a US Permanent Resident (No “Green” Card”)
 Not present in the for “too long” - 183 day weighted counting test
over 3 year lookback period triggered by current year presence of
over 31 days.
 Entity – Not chartered in the US (50 states, federal, and territories and
possessions)
Transfer Tax (Estate and Gift)


Individual – domicile test – home is where the heart is
Entities – N/A
One Size Does Not Fit All



Since every transaction is different, no single solution fits
every case
Structure appropriate for a non USA resident family with
an aging patriarch who wants to invest $95 million
dollars in active rental and developmental properties
vacant land is probably unacceptable for the 35 year old
son of the family who wants to buy a Manhattan condo
to live in while on assignment in the US for five years
We’ll discuss that more when I get to the case study.
Effect of The Fiscal Cliff


The classic US tax trade off was/is using
corporate holding structures to avoid estate tax
(35% top rates) at the expense of higher
income (35% top rates for corporate vs. 15%
for capital gains for individuals)
This equation may change to tilt the preference
to corporate structures in 2013 with estate taxes
slated to go up to 55% top rates, corporate
rates perhaps to come down (e.g. to maybe 2528%) and capital gains rates to go up to 20%.
A Note on LLC’s



These are very “hot” in the US
However, they don’t tend to mix too well
with tax treaties
Hence, generally to be avoided in the
context of holding structures for foreigners
investing in US real estate
Non-US Effects Must Always be
Taken into Account


US Real Estate investments for foreigners
cannot be handled in a US vacuum
It is essential to work with local tax
advisers in the home country to make sure
that minimizing US tax does not have an
untoward consequence in the home
country that may more than offset the
“savings” in the US.
Don’t Forget Transaction Costs


In the US lawyers (who can be pricey) not
notaries handle the legal end of real
estate – On the other hand a lot of US real
estate lawyers are looking for work so it is
a “buyer’s market” for the clients!!
State and local government non-income
tax expenses can be very high – More on
this in a bit
A Word on FIRPTA





This is a big exception to the rule that non_US residents
are not generally subject to US income tax on capital
gains from US Sources
FIRPTA treats all sales by non-US residents as subject
to mandatory 10% withholding on the gross proceeds of
the sale
However, this is not the actual tax which is only on the
gain so a refund can and should be applied for where
applicable.
The tax is imposed at the applicable graduated US rates
So a US return must be filed in addition to just having
the withholding done.
Case Study – The Schiller
Group





A wealthy Central Eurozone family.
So let's hedge $95 MM of their € with a US real estate
portfolio which they will be 50-50 partners with a US
realty group based in NYC.
Also let's give them a 35 year old single son who is
going to live in the US for a couple of years to get the
US biz going soundly.
Naturally we want him to live in a condo on Park Avenue
which he or the family will own at a purchase price of $5
MM.
We’ll start with the commercial holdings.
The Commercial Portfolio



We are going to have our Schiller Group invest in active
real estate ownership of income producing and property
development (e.g. improvements and construction)
The general rule is to set up a separate holding company
for each piece of property
Big step is to consult with home country counsel. We
are assuming no home country tax problems for the
sake of this discussion.
The Commercial Portfolio


Generally, advisable to partner with an
experienced US operator.
We generally see a three layer structure



A Foreign Company
Owning a US Company (here US companies)
US Companies own the real estate
Reasons for the Structure



Foreign Co – Avoids US Estate Tax – At what
may well turn into 55% rates next year
US Co - This Avoids a 30% Branch Profits Tax
which is imposed on top of the 35% (maybe 25
to 30%) Regular US Tax Rate
The more than 80% common ownership of each
separate company will allow the filing of tax
returns on a consolidated basis – so income of
one project can be offset by expenses of
another
Funding - Debt or Equity




It is generally more tax efficient for US tax to use debt
rather than equity
Interest on debt is deductible against income
Interest payments to the foreign holding company are
often subject to favorable treaty withholding rates – e.g.
the rate is nil under the US Germany tax treaty
Note: Local counsel in the home country would have to
be consulted on tax effect in home country
Beware Earnings Stripping
Rules



To avoid treatment as dividend the ratio
of debt to capital cannot exceed 3:2
If it does there will be no deduction
allowed for interest
AND the entire payment amount not just
the interest element will be subject to
withholding – e.g. 50% German owner
would have 15% US withholding
The Tax Downside


Gains will be taxed at 35% (maybe 25%
to 29% under Obama Romney proposals)
Outright ownership would have taxed gain
at 15% (maybe 20% under fiscal cliff)
Downside Solution – 1031
Exchange


Gains can be deferred by swapping into
other higher priced “like kind” property
This device too can be used to sell shares
of the foreign company free of US tax at a
higher price on account of the ability of a
US buyer to defer recognition of the gain
through a 1031 exchange
General Design for the Son






We would likely look at having him own the condo outright. Let’s
say this condo costs $5 million
If the property appreciates after his stay here and is sold at a gain
then the tax rate is 15% on the gain (perhaps 20%)
The exposure is estate tax (at perhaps 55% rates) if he dies while
living in the US but since he is young and healthy with no
dangerous hobbies this is not likely.
A 5 year term life policy for a 35 year old male in excellent health
for say $2.5 million would cost perhaps $1,250 per year.
C.F. If we planned to avoid estate tax (he will likely not be a US
resident for estate tax purposes) with say a foreign corporate
ownership we would add FIRPTA complications (10% withholding
on sale) plus tax at perhaps 25-35% on the gain
N.B. We are absolutely assuming away any home country tax issues
that this transaction raises.
Costs of Buying and Selling New York
State and City Condo

These costs typically are:




A “Mansion” Tax of 1% of the total contract price if the price is $1,000,000 or
above.
New York State Real Estate Transfer Tax of $4 per thousand (.4%)
New York City Real Property Transfer Tax of 1% on transfers less than or equal
to $500,000, or New York City Real Property Transfer Tax of 1.425% on
transfers over $500,000.
Mortgage Recording Tax (if the buyer is obtaining a mortgage loan):
 Under $500,000: 2.05%, of which .25% is paid by the lender.
 Equal to or greater than $500,000: 2.175% of which .25% is paid by the
lender.
Purchasing the Condo – Putting
Numbers to the Costs



The following is an example of the costs of purchasing a New York City
condominium apartment from a sponsor. Assume a $5,000,000 purchase
price and a $2,500,000 mortgage.
The Schiller son will pay, in addition to the contract price, approximately
$204,9823 consisting of the following:
 “Mansion Tax”: $50,912 (payable by all buyers)
 New York City Real Property Transfer Tax: $72,550
 New York State Real Estate Transfer Tax: $20,365
 Mortgage recording tax: $46,875
 Title insurance: $14,280
The Schiller son may also be required to pay a contribution to a working
capital fund equal to one or two month’s common charges and the
sponsor’s attorney’s fees for attending the closing.
THANK YOU!
Robert J. Kiggins
Counselor-At-Law
McCarthy Fingar LLP
11 Martine Avenue
White Plains, NY 10606
Tel (914) 946-3700 Ext. 324
E-mail: rkiggins@mfdds.com