Buying a Property in the US
How to Navigate Tax Implications – at Home and in the US
The great news about buying a property in the US is that, in general, the US market is welcoming to foreign buyers. As a non-resident, you will not suffer any additional fees or government restrictions, and the purchasing process is very similar to that of a domestic buyer.
However, the tax implications as a foreign investor of buying and also selling property in the US can catch you out if you are not fully prepared. In some cases, poor tax planning can lead to substantially larger tax burdens, especially if you are not aware of how to structure your purchase to avoid certain costly taxes. But, with effective tax planning you can avoid these pitfalls – and even reduce your tax burden to significantly less than an American resident might pay.
In this guide, we’ll walk you through the main tax implications you need to be aware of when purchasing and selling property in the United States, and how you can protect your assets, and ensure your tax burden is minimized.
On This Page
- The Complexities of Tax on Real Estate for Foreign Investors
- Taxes on the Purchase of Your Property
- Taxes on the Sale of Your Property
- The Foreign Investment in Real Property Tax
- Creating a Real Estate LLC
- Ongoing Property Taxes
- Reducing Your Real Estate Income Tax
- Inheritance Taxes
- Gift Tax
- Asset Protection
- Tax Planning at Home – Things to Consider
- Get Expert Support for Real Estate Tax Planning
- Frequently asked questions (FAQs) about taxes, company formaition, and residency in the U.S.
- Get advice on taxation, company formation, and residency in the U.S.
The tax implications for foreign buyers in the US can be complex. Real estate in the US is highly tax-driven. The US Federal government imposes taxes such as Income Tax, as well as transfer taxes which include Estate Tax, Gift Tax and tax on Capital Gains. For foreign investors, there is also taxation on the disposition of real estate, known as FIRPTA.
In addition to the taxes imposed by the Federal government, you will also be expected to pay any tax due at a state or county level (which will vary according to state or county) – including annual property taxes if these are applicable.
As well as navigating the tax requirements applicable in the US, you will also need to be aware of how buying a property in the US will impact your tax obligations in your home country. For example, will double taxation be an issue? Will you have to pay taxes in your home country above taxes in the US or does your country have a tax treaty with the US or a foreign tax credit that you can take advantage of? Will your heirs be taxed on property that’s part of your estate in the US or at home?
As part of your tax planning, you will need to explore how these issues will impact you, and also decide which method of purchase will work best for your unique situation. For example, will you buy property as an individual, or establish an entity in the US such as a real estate LLC to buy the property?
Making these decisions requires a wide range of factors to be taken into consideration, which is why we strongly advise that you take expert advice from tax advisors who are experienced in working with foreign buyers of property in the US. Mount Bonnell Advisors can offer you comprehensive support with your real estate tax planning, with a range of support services which you can find details about at the end of this guide.
First, let’s take a closer look at the range of factors you need to consider regarding real estate taxation.
One of the first things foreign buyers want to know is whether there will be a general tax on the purchase of property in the US. The US does not use terms such as Stamp Duty (used in the UK) to refer to taxes on the purchase of the property – instead, they use the term “Closing Costs.”
Closing Costs are due when you buy a property but these are the same costs as any US citizen would pay, and you will not be expected to pay higher closing costs as a foreign purchaser. These costs are typically broken down into the following:
- Mortgage tax if you are using a mortgage for financing, paid to the government. This is approximately 2% of your loan amount.
- Title Insurance – This insurance makes sure your new home has a clean title.
- Attorney fees.
- Mansion Tax in some states – for example, 1% of the property price if the property is $1 million and above.
- Recording and search fees.
- Banks Fees.
Overall, Closing Costs are around 5-6% of the loan amount if you are using financing. If you are not using financing, Closing Costs are around 1.5-2% of the property price.
When you sell your property you will be subject to the same Closing Costs as US residents. You will also be subject to capital gains taxes known as FIRTPA withholding tax.
Closing Costs as a Seller
As a seller, Closing Costs are typically broken down as follows:
- Broker Commission – usually around 6% of the purchase price and split 50/50 between buyer’s and seller’s agents.
- Attorney Fees
- Recording and Filing Fees
You may also be subject to a Transfer Tax. This tax is imposed by the state, county and municipal authorities for transferring real property within the jurisdiction. The tax is based on the property value and classification.
In general, your Closing Costs are around 8% of the sale price.
As a foreign seller, you will be subject to the Foreign Investment in Real Property tax, known as FIRPTA. This tax is due because foreign investors aren’t taxed on most capital gains in the US, so the IRS requires the withholding of 10% of the gross sale price of the property to ensure that the US government receives tax revenue.
This amount can be well in excess of the capital gains tax on the net sales price and in some cases less than the net cash received by a foreign investor after payment of the mortgage on the property.
When you submit a US Tax Return you will receive a tax refund if the amount withheld exceeds the amount of tax due. This means that, though you will have to wait until the end of the year of sale to receive your refund, overall the correct amount of tax due will be paid.
Capital gains tax for direct foreign ownership is 30%. However, if you buy a property through an LLC, the 10% withholding procedure is eliminated and will reduce your overall capital gains tax. This is one of the reasons why many foreign buyers choose to create a Real Estate LLC to purchase properties.
A major benefit of an LLC is pass-through taxation. LLC’s are taxed as partnerships, despite them offering corporate-like protections against liability. C-corporations are subject to double taxation – at the corporate level and when dividends are distributed to shareholders. By contrast, an LLC is classified as a “disregarded entity” which means income and capital gains from the LLC pass directly to the owner who only pays tax as an individual.
In the next section, we’ll look at creating an LLC before exploring how it can be used to reduce other tax burdens.
A limited liability company – LLC, has become a popular way for many real estate investors to use as an entity to buy property. By creating this entity for real estate purposes you can use it to obtain a tax identification number and operate as a business.
One of the biggest advantages to an LLC is that the members who form it are not personally liable for any debts or other types of liability incurred by the LLC. This means that they can be used to minimize personal monetary and legal risk. An LLC can also provide you with extra privacy because you do not have to publically register your ownership of the LLC.
Setting up an LLC can be done quickly and simply under the advisement of an experienced professional.
The steps that need to be undertaken are:
- Researching individual state rules on setting up an LLC and choosing a business name.
- File “Articles of Organization”. This document must be filed with the state’s LLC office which is usually the Secretary of State. Once this is approved your LLC is considered officially formed.
- Create an Operating Agreement. This document shows how the LLC will be organized and run. Examples of policies might include the rights and duties of members, choosing managers, and how profits and losses are to be distributed.
- Publish intent to file. Some states require you publish an intent to file via the local newspaper.
- Obtain any required licenses and permits and apply for a tax identification number.
The ongoing taxes you pay on a property will depend on how you intend to use the property and which state your property is located in.
In many states, an annual property tax is due each year. This can be a major source of income for the US government – in 2016, American homeowners paid almost $278 billion in property taxes, with each of the 84 million single-family homeowners paying an average of $3,296 – around 1.15% effective tax rate.
The amount you pay will depend on which state you buy your property in. The IRS has provided links to state revenue sites where you can find out what taxes are due in each state.
US residents (including Green Card holders) are subject to income taxation on their worldwide income, however, Non-Resident Aliens (NRA’s) are only taxed on income earned in the US. However, even if you are an NRA you can fall foul of this rule if you pass the Substantial Presence Test.
This test looks at whether a non-US citizen has been physically present in the US for 31 days in the current year or more. Then it calculates the number of days present at one-third of the number of days present during the first preceding calendar year and one-sixth of the number of days present in the US during the second preceding year.
If the formula adds up to 183 days or more then even as an NRA you will be taxed as a US resident – including on all your worldwide income.
If you intend to rent out your property or use it to gain any other income you will be subjected to income tax. The US taxes foreign buyers when they receive “US source income” – which includes rents.
To pay taxes as a foreign national you must elect to pay US Income Taxes on rental or any other property income and ensure you file on time. If the filing is not made on time you will be subject to a 30% tax and be unable to deduct expenses such as depreciation, interest, and property taxes.
There are two ways that you can be taxed on passive rental income on real estate as a foreign owner. The first is the default gross amount. The default withholding tax is 30% of the gross rent. The payer of the rent is the withholding agent and they are obligated to withhold 30% of the rent and pay it to the IRS.
However, there is a much better way to organize your rental income tax. This is the net basis – income less expenses. To take advantage of this you must elect to have rental income treated as “Effectively Connected Income” (ECI).
Once you make this election you need to obtain an ITIN (Individual Tax Identification Number) and make the election with a tax return. You must provide the correct documentation – a W-ECI – to the withholding agent and make quarterly tax payments if applicable. Filing this way is usually much more advantageous than the default gross as you can make deductions for your expenses.
Planning for how you manage the tax burden on your estate is vital as a foreign buyer in the US. This is because, as a foreign individual, if you die while having an estate in the US, Federal tax rates are set at 40% of the overall estate. If you are an American citizen this rule only applies to very wealthy people – the first $5.6 million and $11.2 million for married couples is exempt. However, for a foreign buyer, the exemption is a very low $60,000.
This low exemption can lead to a very large tax bill for your heirs – even if they don’t reside in the US. A good strategy for avoiding this tax is to use an LLC to purchase properties in the US as this will defer inheritance tax to the country of residence.
If you do not choose to use an LLC or other business entity to buy a property another option for reducing this tax burden is to take out an inexpensive term-life insurance policy that is payable to your heirs in order to cover the tax.
Gift Tax in the US applies to foreign investors if the gift is US tangible property – for example, US real estate. You can give up to $15,000 of property tax-free to an unlimited number of persons a year.
However, the remaining amount of the value of the gift will be subject to a 40% gift tax. The only exception to this is if you have a US citizen spouse, in which case they will qualify for a marital deduction. If you buy the property through an LLC then the Gift Tax is deferred to your country of residence.
As mentioned near the beginning of this guide, one reason that many European entrepreneurs choose to use a Real Estate LLC to buy property in the US is in order to protect their assets. Protecting your personal finances is extremely important, especially if you plan to invest in more than one property.
An LLC will limit personal liability to potential lawsuits regarding your property. If there should be any lawsuit, it will be aimed at the LLC, not at the individual responsible. Therefore your risk exposure would be insulated by the company, leaving only assets owned by the LLC exposed. This is a major benefit of creating an LLC. They are relatively inexpensive to set up which is why we believe an LLC may be an excellent solution to tax planning.
When you are undertaking your Tax Planning for real estate in the US it’s important not to forget about what the tax implications might be for you in your country of residence.
For example, if you reside in the UK you will still have to pay UK tax on the US property, as well as any tax due in the US. In many cases, European countries have double taxation agreements with the US. This means that, although you will have to pay tax in your home country on US purchases, you can deduct the amount of tax paid in the US from your home country liability.
It’s important to understand that you can’t get repayment of foreign tax via double tax relief – only the deduction on your tax at home. The best you can hope to do is to reduce your home tax liability to nil. In some cases, the foreign tax may exceed the amount of taxable income or capital gains liable in your resident country. In this case, you may be able to claim foreign tax as an expense rather than claim double tax relief.
In the UK, if you claim foreign tax as an expense and it creates a loss you may be able to carry forward this loss to give you future tax relief – giving you better value as opposed to claiming double tax relief.
There are many variables which change depending on your home country and the agreements in place with the US regarding tax – so the most effective option is to secure the advice of an experienced international tax planner who can help you to navigate the complexities and variables of interacting rules.
The tax implications of buying property in the US can be significant if you don’t get the correct advice and spend time carefully planning your Real Estate Tax strategy.
At Mount Bonnell Advisors, we work alongside highly-skilled tax advisors and attorneys who have experience helping international entrepreneurs to manage and minimize their tax burden.
We can help you with your Real Estate Tax Planning by:
- Offering advice and support to understand the tax system and develop a tax strategy.
- Support to set up an LLC or another entity to take advantage of the tax benefits they can offer.
- Help to file tax returns and manage your taxes to ensure you reduce your obligations as much as possible.
- Consulting with you on what to do if you have made a mistake or incorrectly filed taxes.
Starting a business in the U.S. can be both exhilarating and exasperating. There is much to know and even more to learn, and the pace of the information coming at you can be overwhelming.
That’s where Mount Bonnell Advisors come in.
Would you like to live your very own American Dream? At Mount Bonnell, we can guide you through the labyrinth of regulation and red tape and out into the blue skies of a dream come true – the dream of living and working in America.
Whether it’s technical issues around tax or residency, or strategic ones involving business formation and growth, the experienced team at Mount Bonnell Advisors are here to help.
So make that dream a reality by booking a consultation today with Mount Bonnell Advisors. Let the adventure commence!