In 1980, an act called FIRPTA was enacted in the United States, this act is also known as the Foreign Investment in Real Estate Tax Act. This act taxes foreign Investors seeking to sell their real estate. In order to ensure tax payment to the American tax authorities by foreign investors, in the United States, there is an obligation to withhold tax. In the article before you, we will explain the meaning of this law and discuss the options for minimizing this tax obligation.
Real Estate in the United States and Foreign Investors
In 2007 a financial and real estate crisis broke in the United States and shortly became a global crisis. This event turned the American market into a real estate investment hub. As a result of this crisis, real estate prices declined drastically and foreign investors from all over the world, including many Israelis, decided to take a chance and invest in this market, assuming that real estate prices would eventually rise and make these investments extremely viable.
As with any type of investment, and especially with international investments, it is very important to examine all the taxation aspects that apply to the investment – these may be the factor that determines whether the investment is successful or an utter failure. This is especially true for real estate investments in the United States.
First of all, foreign investors who generate income originating in the United States are obligated to file an annual report listing their income. Filling out and filing this report alone may require the investors to spend large amounts and may also cause bureaucratic difficulties.
Second, foreign investment in the United States is taxable in several ways, and countless provisions of the tax law address it: federal tax, state tax applicable according to the country in which the property is located, a municipal tax is applicable considering municipal affiliation, estate tax, branch tax, and other taxes depending on the specific circumstances of the property.
Among other things, the investment of a foreign investor in American real estate will be governed by the provisions of the FIRPTA which will be explained in the following segments.
Therefore, it is extremely important that any foreign investor seeking to invest in real estate in the United States consults with professionals and conducts a comprehensive tax plan that will take into account all obligations that apply to such investors, including obligations derived from the FIRPTA.
FIRPTA and its consequences
In order to ensure the payment of tax liability by foreign investors, the FIRPTA was enacted. The law imposes on a buyer (and/or the company making the purchase on his behalf) who purchases real estate property from a foreign investor, deducts to the seller (the foreign investor), tax at a rate of 10% of the price of the property, and transfer it to the U.S. Tax Authority (IRS).
Contrary to the usual state of affairs, the tax is levied on the entire amount of the sale and not only on the profit, this means that its rate may be higher than the tax rate that usually applies to such sale. This also means that this is a significant tax burden.
Only after the foreign investor pays his tax liability – both on the rental income in the property and on the capital gain from its sale, will the foreign investor be able to request the tax refund paid. Of course, the refund will be requested and received only after submitting the tax report for the following year.
Strategies for reducing tax obligation and form 8288B
There is an option to minimize the withholding rate by submitting a special request that may reduce the rate and sometimes even eliminate it. An exemption application will be submitted through Form 8288B accompanied by supporting documents, such as transaction documents, invoices documenting details of expenses on the property, previous tax reports, etc.
Another possible solution is to execute the transaction through a local corporation or through a loan to a local corporation that will make the investment. In this situation, income from the interest repayment will be tax-free, while the interest will be taxed at relatively low tax rates. However, this possibility may also have other drawbacks.
For example, if the lender holds more than 10% of the loan recipient, the low tax rates that usually apply to interest income will not apply. Therefore, individual tax planning that corresponds to the specific circumstances of the investment is important.
As you saw in the previous segments, the United States imposes a particularly complex tax regime on foreign investors. However, there are solutions that allow them to minimize their tax obligation. A sensible investor will take care of this matter through meticulous tax planning that will ensure the success of his investment.
The professional and skilled team of MasAmerica will be happy to be at your disposal and make your investment worthwhile.