Taxation of Investments in US Real Estate by Non-US Citizens

TAXATION OF INVESTMENTS IN US REAL ESTATE BY NON-US CITIZENS

A foreign investor who derives income from renting out or the disposition of U.S. real estate is generally required to file a nonresident federal income tax return with the U.S. tax authorities (IRS). In addition, there may be a state tax filing requirement, depending on the state where the property is located. The rental income, as well as the capital gain realized on the sale of the property, is subject to tax in the United States.

Tax Treatment

Generally, a foreign investor is classified as a ‘nonresident alien’ under the U.S. tax code. As such, a foreign investor is subject to tax in the United States on his income from U.S.-sources. Income derived from renting out and the disposition of U.S. real estate must be reported to the IRS on a nonresident federal income tax return. Nonresidents are taxed on a gross basis at a tax rate of 30%, but can generally elect to be taxed on a net basis at graduated rates. Being taxed on a net basis allows deductions for depreciation, taxes, and other expenses.

Tax Treaties

Most tax treaties, including those entered into by the United States, allocate the right to tax income derived from real property, including rental income and income derived from the disposition of real property, to the country where the real property is located, instead of the country where the seller is located. However, a tax treaty may lower the rate at which tax is withheld on the sale of the property (which would otherwise generally be 30% under the U.S. tax code).

Even though most tax treaties are based on a model, each tax treaty is the result of negotiations between the treaty partners and therefore unique. Careful analysis is required to determine the tax treatment of international tax situations.

Filing a U.S. Tax Return to Report Rental Income from U.S. Real Estate

Unless a foreign investor’s U.S. tax liability on his U.S.-source income is fully satisfied by the tax that was withheld on his behalf, he is required to file a U.S. income tax return (Form 1040NR). A true and accurate income tax return must be timely filed to be allowed deductions and credits.

Rental income from U.S. real estate must be reported on a U.S. income tax return. Deductions for depreciation and expenses are allowed, such as expenses for repairs and maintenance, utilities, property tax, commissions, etc.

Withholding Certificate

The buyer of U.S. real property sold by a foreign person is required to withhold tax on the purchase price (generally at a rate of 15%). The foreign person can credit the amount that was withheld on his U.S. tax return. If the amount that was withheld by the buyer is greater than the tax liability as calculated on the U.S. tax return, the difference will be refunded by the IRS. The gain (i.e. the difference between the original purchase price and the proceeds minus adjustments) is subject to tax in the U.S. By filing Form 8288-B, the seller can request the IRS lower the amount the buyer is required to withhold.

Questions?

If you have any questions about the U.S. tax implication of buying U.S. real estate, or if you would like us to prepare your U.S. nonresident income tax return, please contact us.