In this article, we will discuss the types of real estate holding associations facing investors, while addressing the main differences between them. Professional tax planning will take into consideration all of those differences alongside the specific circumstances of the investor, in order to choose the option that will minimize the tax burden.
So if you find yourself in the position where you decided that it is time to invest in real estate in the United States, you have already chosen a property to purchase and all that is left is to just make the deal, you should stop! Because there is a good chance that you have not dedicated much thought to one of the most important aspects of purchasing such a property, that is the way you intend to hold the property. It may seem like a minor bureaucratic detail, some might even leave that decision to be made by the marketing company that sold them the property, but it is a significant matter, to say the least.
The truth of the matter is that disregarding this aspect can cost you a lot of money. The manner of holding the property will determine the tax burdens that will be imposed on you, and will directly affect your income (or, alternatively, your losses).
Holding real estate by an individual
The method of investment
Direct. The individual owns the property as an individual, privately and independently.
The responsibilities of the investor
The investor is fully responsible. The investor’s responsibility is not limited to the amount of his investment, and all his assets and fortunes are subject to claims from creditors.
Federal taxation
A marginal income tax rate applies to the individual according to his income rate.
Taxation of regular income
Income from rental earned by foreign investors is usually classified as FDAP revenue(an acronym for Fix, Determinable Annual, or Periodical). These incomes are taxed at a uniform rate of 30% of the total, with no possibility of deducting expenses.
The classification of such income as ECI income(or in other words: Effectively connected with the conduct of a trade or business), that is, income from a business, will allow the reduction of the tax rate to the marginal tax rate that applies to individuals according to their income (a rate of between 10-37%) and will enable the owner to deduct the expenses from income.
Taxation of capital gains
The income from the sale of a property held under one year by the same investor will be taxed at the marginal tax rate according to the income rates of the investor. The income from the sale of a property held for more than a year will be subject to a reduced tax rate: the profit for the depreciation component will be taxed at a rate of 25%, while the rest of the profit will be taxed at only 15%.
Estate tax
The tax applies to the value of the deceased’s assets when they are transferred to his heirs. If the investor is not a U.S. citizen, the tax will apply to all of the property he owns with a value of above $ 60,000 and the rate of the tax will be 35%. To the extent that the investor is a U.S. citizen, all of the value of his assets above $ 11.2 million will be subject to estate tax at the same rate.
Branch tax
Branch tax will not apply.
Holding real estate through a local corporation(C-CORP)
Methode of investing
Indirect investment through an existing local corporation or one established for the purpose of investment. There are several types of local corporations, but the most common of which is C-Corporation. This legal entity is an entity separate from its owner.
The responsibilities of the investor
The investor’s liability is limited solely to the amount of his investment, the rest of his wealth and assets are not exposed to creditor claims.
Federal taxation
A corporate tax rate on income, followed by taxation of dividend distribution.
Taxation of regular income
Income from rent will be taxed at a corporate tax rate of 21%, and expenses can be deducted from it.
Taxation of capital gains
Income from the sale of the property will be taxed at the corporate tax rate, 21%, and expenses can be deducted from it.
Estate tax
The U.S. law considers the location of the company’s shares within the United States and based on its location the income will be subject to the local rate of the estate tax.
Branch tax
Branch tax will not apply.
Holding real estate through a limited liability company (L.L.C)
Methode of investing
Ownership through a limited liability company – an L.L.C. In this case, as well, the company is a legal entity separate from the investor, with the difference that the uniqueness of a limited liability company compared to another local corporation is that it is a transparent entity for tax purposes. This means that although the company reports its income, in fact, the tax liability applies to the partners who share it up to their relative ownership of the share in the company.
The responsibilities of the investor
The tax liability is limited solely to the amount of the investment, the rest of the investor’s wealth and assets are not exposed to claims by creditors.
Federal taxation
As mentioned above, the tax liability is limited to each of the partners’ shares in the company. Therefore, the tax rate that applies to each of them is the marginal tax rate that applies to individuals according to the rate of their income.
Taxation of regular income
As stated above, the default rate for income from rent income is the same as the rate on FDAP income and stands at a rate of 30%. The classification of income as income from the business – ECI, will allow the taxation of this income at the marginal tax rate applicable to each of the partners according to their income level. In addition, there is a tax deduction benefit at the rate of 20% of its partners’ joint annual income, provided that these do not exceed $ 315,000.
If the income exceeds this amount, you will receive the lower of the two benefits: 1. A tax deduction at the rate of 50% of the general salary of the company’s employees. 2. Tax deduction at the rate of 25% of the salary paid + 2.5% of the basic salary rate.
Taxation of capital gains
The income from the sale of a property held for less than a year will be at the marginal tax rate applicable to each of the partners. If the asset has been held for more than a year, a reduced rate will apply: so a profit for the depreciation component will be gained, this is through a tax of the rate of 25%, while the remaining profit will be taxed at a rate of 15%.
Estate tax
An estate tax will apply according to the rules described above.
Branch tax
A branch tax will not apply.
Holding real estate through a foreign company
Methode of investing
Investing through a foreign company that is a separate legal entity from the investor.
The responsibilities of the investor
The liability is limited to the amount of the investment.
Federal taxation
Tax rate of a corporate tax.
Taxation on regular income
The default is uniform taxation at a rate of 30%. However, the definition of income as income from a business, ECI, will allow the income to be subject to a 21% corporate tax.
Taxation of capital gains
Capital gains will be taxed in accordance with the corporate tax rate of 21%.
Estate tax
U.S. law applies taxes based on the location of the company’s shares outside the United States, and therefore no estate tax will apply to them.
Branch tax
Applies. Branch tax is an additional tax (besides corporate tax) levied on the profits of foreign companies from their operations in the United States, in order to transfer the funds outside the country.
The tax rate is 30%, but under the Tax Treaty between Israel and the United States, the rate was reduced to 12.5%.
Holding real estate through a chain of holding (a company that holds a limited collateral company)
Methode of investing
In this investment type, the holding is indirect. The investor operates through a local or foreign company (the “parent” company), which acquires L.L.C (the “subsidiary” company), which owns the property. Since the L.L.C. company is transparent for tax purposes, the tax will be levied on the parent company.
The responsibilities of the investor
Limited to the amount of his investment only.
Federal taxation
A corporate tax applies.
Taxation of regular income
Rents will be taxed at a uniform tax rate of 30% unless income is classified as income from a business, then it will be taxed in accordance with corporate tax – 21%.
Taxation of capital gains
Income from selling a property will be taxed at a corporate tax rate of 21%.
Estate tax
There will be no estate tax in cases where the parent company is a foreign company. There will be an estate tax if the parent company is a local company.
Branch tax
Will apply as described above if the parent company is a foreign company.
Closing words
There are many methods of holding real estate and every method comes with advantages and disadvantages. Given a sufficient amount of professional knowledge, an optimal tax plan can be created according to the investors’ needs which will ensure minimum tax burden and maximum profit. The Team of MesAmerica is familiar with the various professional aspects of taxation and tax planning strategies and will be happy to assist you with any questions.
