Entries Tagged 'Nonresident real estate investors' ↓

Doom and gloom isn’t new.  What caught my eye here was how the real estate company’s CEO saw US tax policy as a direct inhibitor of foreign inbound real estate investment.  Go to number (2) in the points he raised.

Personally I think this is a bit myopic.  Yes, tax policies matter.  But has anything else in the financial market been happening since summer, 2007?  Oh, hypothetically, a massive meltdown?

Investors that I work with are sitting on their wallets.  They see asset prices decreasing, so there is no great rush to buy.

I think sane business decisions might have a lot to do with why this gentleman sees a sharp decrease in inbound (to the US) capital flows.

(cross-posted to firpta.com)

I wrote an article for the California Society of CPAs and it was published in the November, 2008 edition of  the California CPA.

The article is about estate tax planning for multi-national families, or as I like to say, “tax planning when a border runs through your balance sheet.”

You can find Planning for Cross-Border Families on the CalCPA website.

And gee whiz I wish the webmaster there hadn’t put my email address in spam spider-friendly format.   Cluestick whack upside the head, dude.  Google search it.

This is for the members of my Foreign Investment in U.S. Real Estate Class earlier this week in San Francisco.

We talked about the “net election.”   Here’s the detail I promised.

The law

To learn everything about this, read Treasury Regulations Section 1.871-10.  (PDF).

The effect

Rental income earned by a nonresident owner of U.S. real estate (human or corporation, it doesn’t matter) is taxed harshly by default — 30% of gross rent received is the tax, with no deduction for business expenses.  You know, the little things.  Stuff like mortgage interest, depreciation, property tax, management fees.  That kind of stuff.

By making the election you can change the Federal taxation to the normal method:  the nonresident real estate owner would be taxed on gross rent collected less allowable expenses.

The choice does not require a lot of thought.  “30% off the top?  or 30%-ish off the bottom?”

(Note that this is for Federal income tax, not California income tax).

How to do it

You make this election by attaching a statement to the income tax return.

Here’s what the Regulations require:

An election made under this section without the consent of the Commissioner shall be made for a taxable year by filing with the income tax return required under section 6012 and the regulations thereunder for such taxable year a statement to the effect that the election is being made. This statement shall include (a) a complete schedule of all real property, or any interest in real property, of which the taxpayer is titular or beneficial owner, which is located in the United States, (b) an indication of the extent to which the taxpayer has direct or beneficial ownership in each such item of real property, or interest in real property, (c) the location of the real property or interest therein, (d) a description of any substantial improvements on any such property, and (e) an identification of any taxable year or years in respect of which a revocation or new election under this section has previously occurred. This statement may not be filed with any return under section 6851 and the regulations thereunder.

When it’s effective

It’s effective for the year that you filed, and goes forward into the future until you toggle it off.

And yes you can go back in time, file an amended return, and make it effective then.  If you are within the statute of limitations for claiming a refund, you can file this election.

Memo to all personnel

Do it.

In response to an email I just got from Denis Carrade, here’s another resource.

Denis, you remember we talked in the class yesterday about the interesting situation of having a corporation, and the corporation’s assets are being used by the shareholder for personal purposes.  I can hear the brain klaxons firing up now, just thinking about that.

I mentioned that I had remembered some Tax Court case somewhere involving an alien ownership of a house inside a corporation and how the Tax Court judge casually addressed this situation while breezing by on the way to resolving another issue.

After some brainstorming on Lexis, I found the case.  It is Bigio v. Commissioner and my memory was correct.  The comment by the judge is not on the issue of the case.  The issue the judge was addressing was the “Resident?  Yes or no?” one.

If you look at Footnote 2, I have highlighted the relevant sentence.  The taxpayer owned a property inside a Panamanian corporation and the judge cavalierly marches past it to attribute beneficial ownership to the taxpayer.  The language is mushy, the implications tenuous, etc.

But this is the only case I can think of off the top of my head involving a nonresident alien and a house inside a corporation.

Using the appropriate lolcatz eyerolling, I’d say this is Dicta! in a Footnote!  Translation to English — this case doesn’t answer any questions for us.

For all of the people who were in my “Foreign Investment in U.S. Real Estate” class yesterday in San Francisco (I taught a 1-day course sponsored by the California Society of CPAs Education Foundation), here is one of the things I promised to deliver.

Tax Court Opinion

The Estate of Fung attached (warning: PDF) are from the United States Tax Court, and the affirming opinion from the Ninth Circuit Court of Appeals.

The problem, with easy math

The idea here is to describe the pickle facing heirs of a nonresident alien who has the bad judgment to die while owning U.S. real estate.

Let’s say the nonresident owns real estate and there’s a mortgage on the property.  Let’s make up some numbers.  The property is worth $5,000,000, and the mortgage is $4,000,000.  The nonresident dies.  What’s the estate tax?

Example 1:  nonrecourse debt

If the mortgage is truly nonrecourse (meaning the lender can ONLY go after the property in the event of a default, and can never go after the borrower personally), then the estate tax is calculated on the nonresident’s equity in the property, $1,000,000.

For the sake of our example, let’s say the applicable estate tax rate is 40%.  The heirs sell the property, pay off the mortgage, give Uncle Sam $400,000 ($1,000,000 equity times 40% tax rate = $400,000 estate tax), and go home with $600,000.

Example 2:  recourse debt

If the mortgage is recourse (meaning the lender has the option of going after the borrower for personal liability on the debt in the event of a default), then the estate tax is calculated on $5,000,000 — the gross value of the real estate, without deducting the mortgage.

The heir sell the property.  Pay off the mortgage ($4,000,000).  They have $1,000,000 of cash left over.  Now they tote up the estate tax on a $5,000,000 asset at 40% = $2,000,000.  Note the conundrum:  the mortgage plus the estate tax liability adds up to a bigger number than the cash on hand.  The heirs get nothing.

My God!  Is there no mercy?

Seems insane, doesn’t it?  Well, in fact there is a way to get that mortgage to help reduce the estate tax.

On the nonresident dead guy’s estate tax return (Form 706NA) (warning:  PDF) the executor will report the nonresident dead guy’s worldwide balance sheet.  (!)  Then there is some higher math involved.  The details of the higher math are unimportant for our purposes–we’re just talking concepts here.  But if you’re looking for specifics, look at the instructions for Schedule B of Form 706NA.

The idea is that since the nonresident dead guy only has U.S. estate tax on his U.S. assets, you have to do a pro-rata allocation of debt based on a fraction that looks like U.S. assets (numerator) divided by worldwide assets (denominator).

The answer is usually pretty grim.  Usually your nonresident dead guy has LOTS of assets outside the United States, and only a little bit in the United States.  This means that when you pro-rate that $4,000,000 mortgage, it’s not going to end up being all that big of a deduction from the gross estate in order to arrive at the taxable estate.

Which means that the tax savings for going through this exercise are likely to be relatively small.

And the heirs aren’t going to want to tell the U.S. government all about nonresident dead guy’s worldwide assets.  Maybe they don’t want to spend the money for accounting and legal fees to do this.  Maybe they’re just not interested in doing all of the necessary work.  But more likely it is because of a healthy desire for privacy.

Action plan

If you have a situation like this (nonresident owner of U.S. real estate, and mortgage on the real estate) first look at the loan documents very carefully, and come to a professional conclusion as to whether it is a recourse mortgage or a nonrecourse mortgage.

If you have a recourse mortgage, do a quickie spreadsheet to calculate out the value of reporting worldwide income in order to use the mortgage to reduce the size of the taxable estate.  Tell your (alive) nonresident alien investor or the (dead) nonresident alien investor’s heirs that number.  Let them tell you whether they’re willing to report worldwide assets on Form 706NA.

I’m guessing the answer is “Not!”

Thanks

Thanks to all of you who came to the course.  Please keep in touch.  Subscribe to the RSS feed here so you’ll get updates of stuff we talked about.

I spoke in Palm Springs a couple of weeks ago to an enthusiastic and large group of Realtors about representing foreign buyers and sellers of real estate. (There is a pretty large snowbird contingent in the Coachella Valley).

Louis Perlin of Marilyn Perlin Realtors, Inc. in Palm Springs was kind enough to introduce himself after the my talk. Now he has written an article for the Hi-Desert Post, a local newspaper that is not online, unfortunately. It’s unfortunate because his article talked about my speech:

Recently, I was lucky enough to sit in on a presentation made by Philip Hodgen, an attorney who specializes in taxes and how they affect a non-resident. I was only thankful that there were no flies in the room for my mouth was wide open during the entire presentation. What I know about tax laws affecting both resident and non-resident owners wouldn’t fill a thimble.

After the presentation I spoke to Mr. Hodgen and he was kind enough to allow me to make his presentation on non-resident ownership available to any of my readers. If you would like a copy of the presentation made on Aug. 10 at the Palm Springs Regional Association of Realtors, just give me a call and it will be mailed immediately at no charge.

I’m famous in the desert, at least!

Thanks, Lou.