Tax Planning Considerations for the Purchase of a Residence in the U.S. by Foreign Buyers
Many factors influence a foreign buyer’s decision to purchase residential real estate in the United States. Generally, most of these decisions tend to be driven by concerns over political and economic uncertainty in the buyer’s home country. Most foreigners do not leave their home country, family, and friends for trivial reasons.
The combination of economic and political stability, along with a stable currency and low inflation, continue to make the United States a desirable destination. Numerous non-Americans discovered this truth a long time ago. In many large metropolitan areas of the U.S., wealthy individuals and their families can live without personal scrutiny and threat to their personal freedom and security. Thus, many foreigners purchase a personal residence as an investment and a safe haven from their own countries in the pursuit of their own version of life, liberty, and the pursuit of happiness on American soil. On a different level, the major metropolitan areas in the U.S. are frequently more affordable than are other large cities around the world. A dollar denominated investment in a “hard asset” such as real estate provides an excellent hedge against inflation (as many South American, European, and Asian buyers know all too well). Also, frequently, foreigners send their children to college in the U.S., and the children frequently remain in the U.S. for a number of years after graduation. As home financing options are less available in many countries than in the U.S., many foreigners purchase the U.S. residence outright. As a result and by definition, these foreigners have substantial assets in the U.S. for tax purposes.
Originally published in Journal of Taxation of Investments on January 1, 2015.
Please see full article below for more
Tax Planning Considerations for
the Purchase of a Residence in the
U.S. by Foreign Buyers
Gerald R. Nowotny*
Many foreigners purchase a personal residence as an investment
and/or a safe haven from their own countries. In the past, such
purchasers assumed they would not be liable for U.S. income
taxes. That is not a safe assumption in light of the Tax Court’s
2012 ruling in Parker. The author reviews the tax planning considerations
and suggests that the common thinking about how to
structure the purchase of a home in the U.S. needs to be reviewed
and reconsidered.
Introduction
Many factors infl uence a foreign buyer’s decision to purchase residential real
estate in the United States. Generally, most of these decisions tend to be
driven by concerns over political and economic uncertainty in the buyer’s
home country. Most foreigners do not leave their home country, family, and
friends for trivial reasons.
The combination of economic and political stability, along with a stable
currency and low infl ation, continue to make the United States a desirable
destination. Numerous non-Americans discovered this truth a long time ago.
In many large metropolitan areas of the U.S., wealthy individuals and their
families can live without personal scrutiny and threat to their personal freedom
and security. Thus, many foreigners purchase a personal residence as
an investment and a safe haven from their own countries in the pursuit of
their own version of life, liberty, and the pursuit of happiness on American
soil. On a different level, the major metropolitan areas in the U.S. are frequently
more affordable than are other large cities around the world. A dollar
denominated investment in a “hard asset” such as real estate provides
an excellent hedge against infl ation (as many South American, European,
* Gerald R. Nowotny, J.D., LL.M., is a partner with Osborne & Osborne, PA in Boca
Raton, FL. He is a tax and estate planning attorney and a specialist in planning solutions
using private placement insurance products. He may be contacted by email at grnowotny@
aol.com.56 JOURNAL OF TAXATION OF INVESTMENTS
and Asian buyers know all too well). Also, frequently, foreigners send their
children to college in the U.S., and the children frequently remain in the U.S.
for a number of years after graduation. As home fi nancing options are less
available in many countries than in the U.S., many foreigners purchase the
U.S. residence outright. As a result and by defi nition, these foreigners have
substantial assets in the U.S. for tax purposes.
Level of Foreign Investment in U.S. Residential Real Estate
The level of foreign investment in U.S. real estate is signifi cant. The total
amount of foreign purchases of residential real estate was $68 billion in
2013. 1
This number is down from 2012 when the total amount of purchases
was $82 billion, 2
but it is still substantial.
On a national level, Chinese investors accounted for 12 percent of the
home purchases by foreign buyers in 2013, or $8.16 billion in U.S. residential
real estate in 2013, according to the U.S. National Association of Realtors.
3
Canadians were purchasers in 23 percent of the transactions, Mexicans
8 percent, and citizens of three European countries (the United Kingdom,
Germany, and France) 10 percent. South American buyers made 7 percent
of the purchases. 4
Florida has always been a popular market for foreign home buyers. Foreign
purchases accounted for 23 percent of all of the residential real estate
transactions in Florida in 2013. Latin American buyers accounted for 29 percent
of these transactions while European buyers accounted for 23 percent.
Canadians made 39 percent of all of the foreign acquisitions in Florida. 5
Tax Planning Considerations
Traditionally, the tax structuring for wealthy foreigners in regard to the purchase
of a U.S. personal residence has focused on federal estate tax considerations
and not on federal income taxation. As a practical matter, one might
ask, why would the foreign homeowner worry about income taxation if there
is no rental income associated with principal residence? In fact, however,
there are reasons to consider the income tax as well.
1
National Association of Realtors, “2013 Profi le of International Home Buying Activity,”
at 2, available at http://www.realtor.org/sites/
2
Id. at 4-5.
3
Id. at 2.
4
Id. at 15.
5
National Association of Realtors, “Profi le of International Home Buyers in Florida
2013 Report,” at 20, available at http://osceolarealtors.org/wp-
downloads/2013/10/2013-
6
See IRC § 7701(b)(1)(A).
7
See IRC § 7701(b)(3).
Income Tax Issues. The tax code provides for taxation on worldwide
income for any non-citizen who has a green card (i.e., a permanent residence
visa), meets the substantial presence test, or makes an election under Section
7701(b)(1)(A) to be treated as a permanent resident in the fi rst year of
residency. 6
For the nonresident alien (NRA), U.S. tax planning is a delicate
balance of income and estate tax considerations. An NRA would normally be
taxed for income tax purposes exclusively on U.S. source income. The tests
for residency for income tax purposes are described below. If an individual
satisfi es one of these tests, he or she is no longer a nonresident.
The Green Card Test. Under the green card test, a person holding a
green card is considered a U.S. resident for income tax purposes. The green
card holder continues to be treated as a U.S. taxpayer unless the taxpayer
proactively makes an effort to relinquish or revoke green card status.
The Substantial Presence Test. The substantial presence test of Section
7701(b)(3) looks at the number of days over a three-year period that an individual
is physically present in the U.S. An individual is substantially present
if he or she is present for at least 31 days during the current year and at least
183 days, calculated using a weighted formula, for the three-year period ending
on the last day of the current year (December 31). 7
The formula weights days in the current year more heavily than days in
prior years—using a multiplier of one for the days in the current year, onethird
for the fi rst preceding year, and one-sixth for the second preceding year.
(Regardless of the formula, the substantial presence test is not satisfi ed if the
taxpayer is not in the U.S. for at least 31 days in the current tax year. Furthermore,
the taxpayer does not have to prove a “closer connection” to the home
jurisdiction than the U.S.)
Example 1 illustrates how the formula works.
Example 1: Assume Chico Da Silva spends 120 days in the U.S.
in 2014 as well as 2013 and 2012. The weighted total of days is
calculated as follows:
Year Application of Formula
2014 120 days x 1 = 120 days
2013 120 days x 1/3 = 40 days
2012 120 days x 1/6 = 20 days
Weighted Total = 180 days 58 JOURNAL OF TAXATION OF INVESTMENTS
8
See IRC § 7701(b)(3)(B).
9
See IRC § 7701(b)(3)(A).
Since the weighted total is less than 183 days, Da Silva would not
satisfy the substantial presence test and thus would not be subject
to U.S. federal income taxation on his worldwide income.
The Closer Connection Test. The closer connection test, an important
exception to the substantial presence test, provides that if the NRA is able to
demonstrate to the IRS (using Form 8840) that he or she has a tax home in
a foreign jurisdiction and has a closer connection to that foreign jurisdiction
than to the United States, the individual will not be treated as a U.S. taxpayer,
so long as the individual is present in the U.S. on fewer than 183 days during
the current taxable year. 8
The “tax home” is the taxpayer’s home for determining deductible
business travel expenses while away from home. The closer connection test
requires a more subjective analysis, based on intent, than is required under
the substantial presence test. The analysis focuses on (1) the amount of time
spent in the U.S. versus in the foreign jurisdiction, (2) the value and locations
of homes, and (3) whether the homes are owned or rented. 9
In addition, the
analysis considers the following factors:
• Time spent in the U.S. due to health problems or political problems
in the home jurisdiction;
• Location where the taxpayer’s family and friends are situated;
• Location of valuable personal property;
• Visa status;
• Jurisdiction where the individual is registered to vote;
• Jurisdiction of driver’s license;
• Location of business interests; and
• Location of religious and social affi liations.
Election to Be Treated as U.S. Taxpayer. There are times when a foreign
buyer might want to take advantage of U.S. tax benefi ts and treatment.
Or, in some cases, a foreign buyer might want to be treated as a U.S. taxpayer
in order to take advantage of treaty benefi ts from a third country that
is not the taxpayer’s residence. The fi rst-year election allows an individual
to make an affi rmative election to be treated as a U.S. taxpayer providing
the individual is present in the U.S. at least 31 consecutive days in the current
tax year and is present for at least 75 percent of the days in the testing
period. The testing period starts on the fi rst day of the consecutive 31-day PURCHASE OF A U.S. RESIDENCE BY FOREIGN BUYERS 59
10 See IRC § 7701(b)(4).
11 See IRC § 2502(a)(2).
12 Richard A. Cassell et al. “U.S. Estate Planning for Nonresident Aliens Who Own
Partnership Interests,” 31 Tax Notes Int’l 563 (2003).
13 See IRC §§ 2503(b), 2503(c), 2522(b).
14 The U.S. has estate and gift tax treaties with Australia, Austria, Belgium, Canada,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, South
Africa, Sweden, Switzerland, and the United Kingdom.
period and December 31 in the year of election. In addition, the individual
must meet the substantial presence test in the next tax year. 10
Federal Estate and Gift Taxation. The U.S. gift tax regime applies to
gratuitous transfers of property made during the donor’s lifetime. For NRAs,
the gift tax only applies to a gratuitous transfer of U.S. situs real and tangible
property. 11 The IRS position on this is ambiguous. Commentators have suggested
that a look-through to the situs of the underlying assets seems to be a
more cautious approach. 12
NRAs are permitted to make tax-free transfers of U.S. situs real estate
and tangible personal property up to the annual exclusion limit (in 2014 and
2015, $14,000 per donee). NRAs also may make (1) unlimited charitable
gifts to a public charity and (2) gifts on behalf of donees directly to educational
and medical institutions. 13
The unifi ed credit for federal gift and estate taxes for NRAs is dramatically
lower than for U.S. citizens and residents. The unifi ed credit for
the NRA, which has not had the benefi t of indexing since inception, is only
$60,000. However, the U.S. has estate tax treaties with 16 different countries.
14 These tax treaties generally provide three benefi ts for the taxpayer:
1. They provide a restriction to limit taxation at situs;
2. They provide additional deductions and exemptions that would
otherwise be unavailable under internal law; and
3. They provide specifi c methods for relieving double taxation.
Determining Situs of Partnerships and LLCs. There is uncertainty as
to the situs of a partnership or LLC for federal estate tax purposes. The IRS
will generally not rule on the issue. The taxation of an NRA’s LLC or partnership
interest depends on which of two approaches is applied—the aggregate
theory or the entity theory:
• Aggregate Theory: Under the aggregate theory, the partnership interest
is viewed as a pro rata interest in each of the underlying assets. 60 JOURNAL OF TAXATION OF INVESTMENTS
15 TC Memo. 2012-312.
16 See Comm’r v. Riss, 374 F2d 161, 166-167, 170 (8th Cir. 1967), aff’g in part, rev’g in
part TC Memo. 1964-190; Melvin v. Comm’r, 88 TC 63, 80-81 (1987), aff’d, 894 F2d 1072
(9th Cir. 1990); Falsetti v. Comm’r, 85 TC 332, 356 (1985).
17 Ireland v. U.S., 621 F2d 731 (5th Cir.1980); Palo Alto Town & Country Village, Inc. v.
Comm’r, 565 F2d 1388 (9th Cir.1977), remanding TC Memo. 1973-223; Comm’r v. Riss,
supra note 16.
The place of organization is irrelevant; one looks to the underlying
situs of the partnership’s property.
• Entity Theory: Under the entity theory, the partnership is viewed as
being separate from its partners. The approach looks to the location
where the partnership is formed or the residency of the partnership
for income tax purposes in order to determine the situs of the partner’s
interest in the property.
Issues for NRAs When Structuring the Purchase of a
U.S. Residence
The Parker Case. The 2012 Tax Court case of G.D. Parker, Inc. v. Commissioner15
is the proverbial “game changer” for this planning scenario and
shifts the focus to income tax considerations with respect to the purchase of a
U.S. residence by a nonresident alien. The case is a perfect example of what
can go wrong.
Genaro Delgado Parker, a wealthy Peruvian, had a large ocean-front
home in Key Biscayne. Parker owned a Florida corporation which had a number
of subsidiary companies, including another Florida corporation that actually
owned the Key Biscayne home. The shares of the holding company were owned
by a Panamanian corporation. In this respect, Parker did what a large number of
foreign buyers have done when it comes to purchasing a personal residence.
Parker and his family lived in the Key Biscayne home rent-free for several
years (2003-2005). The IRS disallowed deductions for G.D. Parker, Inc. under
Section 262 for repairs and maintenance and depreciation on the basis that these
deductions were personal and family expenses and not business expenses. These
expenses over a three-year period averaged about $125,000–$150,000 per year.
Furthermore, the IRS treated the rent-free use of the house as a constructive
dividend paid to Parker through the corporate chain up to Parker personally.
When a shareholder or his family is permitted to use corporate property
for personal purposes, the fair rental value of the property is includable in his
or her income as a constructive dividend to the extent of the corporation’s
earnings and profi ts. 16 For a corporate benefi t to be treated as a constructive
dividend, the item must primarily benefi t the taxpayer’s personal interests as
opposed to the business interests of the corporation. 17PURCHASE OF A U.S. RESIDENCE BY FOREIGN BUYERS 61
18 TC Memo. 1991-319.
The IRS hired a local real estate expert to determine the fair market
value rent that should be imputed as a constructive dividend and determined
that the fair rental was about $23,000 per month over a three-year period.
Section 881(a) imposes a tax of 30 percent on dividends received from
U.S. sources by a foreign corporation except as provided under Section
881(c), to the extent the dividend received is not effectively connected with
the conduct of a trade or business within the U.S. A lower rate may apply
where the taxpayer has the benefi t of a tax treaty. Section 1442(a) generally
requires the payor of interest subject to the tax imposed by Section 881(a)
to deduct and withhold that tax at the source. If the payor does not do so, it
becomes liable for such taxes under Section 1461. The IRS assessed substantial
accuracy-related penalties and interest in Parker .
The amazing aspect of this case is the fact that the original tax audit
was primarily focused on the taxpayer’s other corporate transactions. Once
you let IRS people into the tent, however, they can look under every stone.
The last thing that the foreign taxpayer wants to do is end up on the fl ip side
of the cliché—“su casa es mi casa” (your house is my house)—as a result of
poor tax planning.
A New Planning Paradigm. The planning paradigm has shifted to a balance
of planning for unexpected estate taxes and income tax considerations
for use of the personal residence. A failure to acknowledge these considerations
could result in Uncle Sam owning the foreigner’s house as a result of
tax liens.
The writing was already on the wall for nonresident aliens purchasing
a homestead in the U.S prior to the Parker case. Some older case law existed
which examined the business purpose of the corporation owning the U.S. real
estate. If the corporation is disregarded, the shareholder can be treated as the
direct owner of the property resulting in an unexpected estate tax. Specifi –
cally, raw land or a residence used by the shareholder poses some concern.
The Bigio Case. In Bigio v. Commissioner ,
18 a nonresident owned a condominium
as a residence and other properties on Miami Beach through a
Panamanian corporation. Absent a lease or loan arrangement, the Tax
Court determined that the nonresident was the benefi cial owner of the
condominiums.
Bigio was principally an income tax case focused on the issue of U.S.
residency based upon the taxpayer’s substantial presence in Miami during
the tax years in question. The Tax Court looked through the ownership by a 62 JOURNAL OF TAXATION OF INVESTMENTS
Panamanian corporation and ruled that Bigio was the benefi cial owner, i.e.,
the court treated Bigio as if he owned the property personally. The structuring
in Bigio did not involve the use of a separate U.S. entity to own the real
estate coupled with the ownership of the U.S. entity by a foreign corporation.
The federal estate tax laws for nonresidents treat shares in a foreign corporation
as non-U.S. situs property.
Potential Problems When an LLC Owns the Property. Many existing
transactions for nonresident aliens owning homes have used an LLC treated
as a disregarded entity to own the U.S. real estate. This structuring poses a
potential estate tax risk with respect to an LLC that is treated as a passthrough
entity—i.e., treated as a sole proprietorship or partnership. The IRS generally
will not issue an advance ruling on whether or not a partnership interest (or
LLC interest treated as a partnership interest) is treated as intangible property
when owned by an LLC. As a result, an LLC that is treated as a disregarded
entity, partnership, or sole proprietorship may be considered a U.S. situs asset
for federal estate tax purposes.
In that respect, making an election to be treated as a regular corporation
is essential for estate tax planning purposes; otherwise a single-member LLC
will be treated as a disregarded entity, potentially subjecting the residence
owned by the nonresident alien to federal estate taxes. Under the aggregate
theory of partnerships, the owner of a partnership interest may be treated as
owning a proportionate interest of the underlying property of the partnership.
How Ugly Can it Get? The revelation that the ownership of the U.S.
homestead is improperly structured is likely to surface during an audit and
will be a big surprise to the taxpayer. The initial estate tax bracket under the
progressive rate structure is 26 percent. The threshold for the nonresident
alien is $60,000 of assets in the U.S. estate. Absent an arm’s-length lease
between the corporation and the nonresident alien, a deemed dividend will be
assessed based upon a fair market rental of the property to the taxpayer.
Corporate-level deductions for repairs and maintenance along with
depreciation will be disallowed. The U.S. corporation is the withholding
agent and is personally liable for the withholding on the dividend deemed
payable to the foreign corporation that owns the shares of the U.S. corporation.
Based upon the personal use of the residence, the withholding tax rate
on the deemed dividend is 30 percent absent a lower rate under a tax treaty.
Federal Tax and Compliance Requirements of Electing to Be Taxed
as a Corporation . LLCs are entities created by state statute. A singlemember
LLC is treated as a disregarded entity for tax purposes absent an
election to be treated as a corporation through the fi ling of Form 8832. PURCHASE OF A U.S. RESIDENCE BY FOREIGN BUYERS 63
19 Rev. Proc. 2009-41, 2009-2 CB 439.
A domestic LLC with two members is treated as a partnership for tax
purposes unless it fi les Form 8832 and elects to be treated as a corporation.
A single member LLC is treated as a sole proprietorship absent an election
to be treated as a corporation.
An election must be fi led within 75 days of the formation of the company.
Alternatively, the IRS allows Form 8832 to be fi led within the fi rst
75 days of the fi scal year which is the calendar tax year for our foreign buyer.
Revenue Procedure 2009-41 permits business entities to fi le a classifi cation
election with an effective date retroactive up to three years and 75 days prior
to the date that the request is fi led. 19
Normally an entity may not change its corporate status within a 60-month
period unless there is a change of ownership of more than 50 percent. The
60-month rule does not apply to an LLC that was a newly formed entity that
made its initial election upon formation. Most entities formed by nonresident
aliens should be able to fall under this rule in regard to making an election for
the LLC to be treated as a corporation for federal tax purposes.
As previously stated in the discussion of federal estate taxes, the corporate
election is critical to avoid U.S. federal estate taxation. The LLC will
require a tax identifi cation number and fi le a Form 1120 each year.
Where Do We Go From Here?
The scale of the potential tax adversity as demonstrated in Parker for foreigners
purchasing a personal residence is signifi cant. It is always alarming
to fi nd out that one may be sleeping in a minefi eld. In the author’s personal
experience, and in the absence of additional guidance on the correct theory of
taxation of partnerships and LLCs, NRAs are extremely vulnerable on both
the federal estate tax and the income tax fronts. Professional advisors never
expected an IRS income tax attack such as that in Parker .
Moving forward, taxpayers and their advisors would be well advised to
revisit their existing structures and make revisions. The Parker decision suggests
that corporate ownership of personal real estate with the shares being
owned by a foreign corporation in order to eliminate U.S. transfer taxes is
still a functional solution.
However, taxpayers should structure an arm’s-length lease with a fair
market rent based on comparable rentals in the jurisdiction where the property
is located. Oddly enough, in many instances the tax rate at the corporate
level may end up being lower than the marginal tax rate of the individual if
the LLC were taxed as a partnersh i p. 64 JOURNAL OF TAXATION OF INVESTMENTS
Summary
The amount of real estate purchased within the United States by foreigners
for either personal or rental purposes is very signifi cant and shows no signs of
slowing down. The common thinking about how to restructure the purchase
of a home in the U.S. needs to be reviewed and reconsidered. The tax mine-
fi eld has new land mines based upon the result in Parker . My legal instinct
suggests that a large majority of foreign owners have not properly structured
their U.S. property ownership. As a result, the tax structuring of each and
every foreign buyer should be reviewed to avoid any unpleasant surprises. Authorized Electronic Copy
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