The U.S. seeks to tax the appreciation of U.S. real estate when sold and tax their value when transferred by gift or upon death. This tax burden falls heavier on foreigners, because foreigners don’t enjoy certain credits and deductions reserved to U.S. citizens and to some “tax residents.” With advanced tax planning, foreign real estate investors can still minimize some U.S. tax consequences of their investments using certain legal structures. For those currently owning U.S. real estate in their individual names (or through an LLC) it is recommended to transfer title of these real property investments to legal structures that will reduce legal risks and avoid unnecessary taxation. It is very important to have a comprehensive plan before signing a purchase/sale contract.
Even if a foreigner does not file U.S. tax returns or have any business in the U.S., owning U.S. real estate results in a U.S. estate tax return filing requirement after the foreigner’s death. The estate of a U.S. citizen or tax resident includes all assets the decedent owned anywhere in the world. On the contrary, a foreigner’s taxable U.S. estate only includes U.S. “situs assets”. The definition of U.S. situs assets includes real property located in the U.S., but excludes some intangible property such as stock in foreign corporations.
The estate tax is levied at a rate of 40% and foreigners only have a $60,000 estate tax exemption or credit. When a foreigner dies owning U.S. real estate, an estate tax is levied on the value of that property in excess of $60,000 and could result in a lien on the property if not paid. Moreover, unlike with the estates of U.S. persons, real estate passing through a foreigner’s estate is generally taxed at its full market value without any reduction for mortgages and regardless of how much they paid for it. An unlimited marital deduction that essentially exempts transfers between spouses is also not available when the surviving spouse is a non-citizen.
The U.S. estate tax may be eliminated for foreigners holding U.S. real property as the U.S. estate tax does not reach stock held by a foreigner in certain types of foreign corporations that in turn own U.S. real estate. In order to effectively transfer indirect ownership of the property upon death, the foreigner uses a will or trust to govern disposition of the stock in the foreign corporation. Since the foreign corporation stock is not a U.S. situs asset, it is not included in the foreigner’s U.S. taxable estate.
In order for such a structure to withstand IRS scrutiny, it must be properly planned, documented and maintained. An estate tax efficient, corporate structure can carry with it income tax consequences that should be weighed considering the type of property, investment horizon, intended use, etc.
An offshore structure properly linked with a carefully structured U.S. LLC holding the property also has several non-tax benefits such as keeping the property outside of a U.S. probate court, as well as providing a certain degree of anonymity as to who is the ultimate beneficial owner of the property. Moreover, the foreigner can be insulated from liability from accidents that might occur on the property if properly structured and operated.
We are regularly called in to “clean up” a situation where the real estate was already purchased using professionals without global tax experience.
Our services for foreign real estate investors include:
 Care must be taken to prevent a foreigner from being taxed as a U.S. person by not establishing a U.S. domicile. The rules for determining domicile for estate tax purposes are quite different from the substantial presence or “day count” rules for income tax purposes.
 In this case, the use of a Qualified Domestic Trust (“QDOT”) could be an option.