EP 007 - Entity Structure and Tax Strategies for Foreign Investors of US Real Estate

Partnering with other investors opens new possibilities by combining resources for larger and more lucrative investments. Many of these potential partners are from outside the US, and are attracted to the strong US real estate market, but there are many complex legal considerations and tax traps to consider.

I have International Tax Attorney and Partner at Culhane Meadows, Patrick McCormick, to help us understand what we can do to properly structure a compliant and tax efficient entity for the investment activity. Together we will discuss the basics of entity planning and tax strategies to ensure the best outcomes for you and your international partners. Areas we discuss are: 

FIRPTA Withholdings 
Estate taxes
Capital gains taxes
FBRAR Income 
Cost segregation and depreciation 
Dividend and branch taxes

Transcript

SPEAKER_00 0:01

Okay. In three, two, one. All right. Welcome everybody. Thanks for coming in. Some of you may be tuning into the recorded version of this. Some of you guys are investors, and some of you guys are gonna be CPAs. Interest is in the topic of structuring and tax strategies for foreign investors into US real estate. Now, there are tons of opportunities here, and I want you guys to think about this, especially you syndicators out there and you people looking for foreign capital and passive investors. The reason why some of these foreign investors may be interested in investing in you and teaming up with you is because the US offers a stable economy. We have a relatively stable government, we have our dollar bill, so that dollar bill valuation of our real estate. We have certain financial systems in place for financing and acquiring debt in a relatively stable environment as well. And then the demographics, we have many thriving and developing metropolises. There are tax incentives to encourage real estate investors, and we are a nation of people who are all descended of other countries. So we likely have connections through either you or your peers of people in other countries looking for places to diversify their investments and invest in potentially in US real estate. But there's lots and lots of other things to consider before you do it. Now, in case for those of you who don't really know me yet, I'm Mark Kroeberg, I'm a CPA, I specialize in real estate tax strategy, and our objective throughout our relationship is to think about things beforehand and to plan in advance as we navigate through the tax code instead of waiting until the last second and realizing we miss out on any opportunities. We want to think about being compliant, we want to consider tax treaties, we also consider all these sorts of withholding requirements that we will get into. There are state taxes, and there are also special treatments of foreign investors when it comes to the disposition of the real estate. Lots of things to consider, and there when we consider these things, we want to consider the proper entity structure and how we can maintain compliance. All these variables to consider and all the opportunities. Patrick, can you introduce yourself? And Patrick's gonna then show us some slides and talk us through some of the considerations you can have with either your clients or you yourself when you're bringing on foreign investors.

SPEAKER_01 2:43

Totally my pleasure, Mark, to be here. Thank you so much for the uh uh invitation to take part today. Thank you so much for having me, and thank you so much to the audience for their participation in today's program as well. Today's and I am yeah, Mark is still telling me I can't share my screen.

SPEAKER_00 3:03

Oh, wait, sorry about that.

SPEAKER_01 3:04

Take your time, no rush.

SPEAKER_00 3:06

Who can you share? Who can start sharing the screen? Here we go. Let's see how this works. Perfect.

SPEAKER_01 3:13

We're all good now. On my end, all good. And here we go. Terrific. The ins and outs of FERFTA is what I've titled today's program, just so the audience is aware. So everybody uh has a bit of context. My entire practice. I'm a United States-based attorney. The entirety of my practice is multinational tax, international tax considerations, whether it's working with what we'll be talking about today, non-residents with United States activities, we term those inbound transactions, inbound activities, or outbound activities, the converse, United States taxpayers with activities, transactions, income sourced to other jurisdictions. What we're concentrating on today are the FERPTA provisions and more generally the uh considerations, tax considerations, American tax considerations, to be even more specific, they come into play when you have a non-resident who is investing in United States SIDIST real property. To what Mark mentioned before, there are tax consequences, and there are very unique tax consequences that come into play on the disposition of a United States real property interest, is a bit of background on the American side. One of the really majorly appealing uh options for non-residents uh looking to invest in a jurisdiction is actually the United States. And the reason for that in part is due to the United States' exemption of capital gains tax for non-residents. If you look at it from a globalized perspective, non-residents with United States activities generally are exempt from capital gains tax on US sourced income to the extent that income does not originate from a United States trade or business that's established by the non-resident. There are special rules, though, that come into play under section 897 of the code, and we'll go into this in detail. But under section 897 of the code, there are special rules that come into play to automatically associate the sale of a U.S. rural property interest with a US trade or business, thereby making that disposition subject to United States tax, even though those dispositions most often would not be taxable on the American side. So let's get started with some background considerations, discussing generally in more detail how non-residents are taxed from an American perspective, default statutory US rules. Non-residents are taxable on income effectively connected with their United States trade or business or what's called their FDAP income, fixed or determinable annual or periodic income. We very often, and it's usually absolutely critical from an inbound representation, when you're working with inbound clients, always critical to evaluate whether the non-resident, excuse me, resides in a treaty party jurisdiction with the United States. That is a country that has a tax treaty in place with the United States. Because if you're looking at, say, in any situation where you have individual who resides in country A and has income that's sourced to Country B, Country B's taxation can be altered dramatically by an income tax treaty being in existence between A and B. If that's the case, the default rules for taxation are modified fairly substantially from a United States perspective. Those modifications are very relevant from a foreign real estate perspective. However, they're less relevant than they are with other types of investments on the American side. And the reason for that is really the and it's intertwined with the reason for the uh gains associated with the disposition of US real property being taxable uh in a special category by the United States. Really, it comes down to uh countries wanting to protect their ability to tax income associated with an asset that, by its very definition, has strong, strong connections to that country. Say if you're looking at stock that is uh, say you have a multinational enterprise that is based in the United States uh and it pays out a dividend to non-resident investors, that dividend is going to be US sourced income. However, you don't see the huge intertwining of the rules, the special rules coming into play. The income tax treaty provisions can be much more forgiving in that context, where you have these entities that, yeah, it's a corporation that's established within the United States, but it can generate income multinationally. It can, by its very definition, have multinational activities. If you have a real property that's located within the United States, then at its very core that all of the income associated with the property has a very strong connection to the United States. As a result, and this isn't unique just to the United States, you see it across jurisdictions. There's a real prioritization from a tax perspective to make sure that a source jurisdiction can capture the income associated with a real property interest located within its country. The trader business standard under default provisions, this is outside the context of real estate. If you're just looking at, say, we have non-resident individual A, and she is a resident of the United Kingdom. She's anticipating exploring the United States market to see whether there are any opportune investments for her. First thing to consider is whether her activities rise to the level of a United States trade or business within the United States. If that occurs, she generates what's called effectively connected income, which means her income tax base from a United States perspective is expanded fairly significantly. Trader business, as I mentioned here on the slide, undefined in the code regulations, case law really dictates what's a trader business from a United States perspective. You're looking at profit-oriented activities, which are regular, substantial, and continuous, being properly classified as a United States trade or business. A couple things to consider in this context. It's really macro level to stress. It's a very low threshold. Activities of an agent can be imputed to a principal. Foreign corporations have been held to have a US trader business just by virtue of having uh sales through a single United States agent, even when the agent has no responsibility or has assumed rather, I apologize, full responsibility for the sales. So there's very minimal uh requirements associated with the uh non-resident trade or business in the United States. FDAP income conversely is a bit of a catch-all category for US sourced income that is not uh categorized as effectively connected income, bit of a catch-all for ordinary income items that are US sourced, that are not subject otherwise to US tax, interest, dividends, uh rents, royalties, annuities, are all covered under FDAP income. There is interplay between effectively connected income and FDAP income. Basically, if an income item fits under both categories, which is very often going to be the case for ECI income, because ECI, if it's ordinary income, it's very likely to fit under the FDAP category as well. When an income item fits under both categories, then the ECI rules are the rules that dictate how the income is going to be taxed. That becomes beneficial on the American side, because what you're really looking at from a functional perspective, in terms of how the income is taxed, effectively connected income is taxed on a net basis at graduated rates, very similar to how a United States-based taxpayer is subject to tax deductions, credits fully available. FDAP income, conversely, is subject to a flat 30% rate of tax under statutory provisions that can be reduced under income tax treaties, taxes collected through withholding by payors. Really critical to stress that for FDAP income deductions, credits, whole nine yards, you don't get to take any of them to offset your FDAP income. It therefore creates a great preference in most cases, and particularly with real estate, where you're producing significant expenses in order to generate income. It can create a significant preference for income to be categorized as effectively connected. And we'll talk about momentarily uh the considerations that come into play there, particular to real estate investments. Here's some more information on how tax occurs and juxtaposing the two categories, like I mentioned before, when you're looking at income tax treaties. You can I'll say as well, when you're looking at income tax treaties, generally, it certainly is not the bulk of what we want to cover today by any means, but income tax treaties generally, from an ECI perspective, they modify the effectively connected income with the United States trade or business category, and it shifts to uh whether business profits are attributable to a United States permanent establishment. It's a heightened standard. However, any rural property income is going to meet, either is going to be whether it's under a treaty or under statutory provisions, uh rural uh income associated with U.S. rural property that's owned by a non-resident is going to pretty much universally be subject to US tax. When you look at FDAP income, the change in tax from an American perspective is primarily related to the rate of taxation. FDAP income from a statutory perspective is subject to a flat 30% rate of tax under treaty provisions. You can uh see rates, uh reduced rates of tax anywhere between 0% to 15%, depending on the type of income item. I'm actually in the process. I was just talking about it with Mark before today's program of writing a full treatise on non-resident taxation, is particularly uh associated with sourcing of income, which is really where everything goes from a non-resident perspective. Anytime questions come up on that end, by all means, feel free to let me know. Here's some more juxtaposition of the ECI and FDAP categories. I think Mark has something to add, so I'll defer to him momentarily and just leave the slide up.

SPEAKER_00 15:16

Oh, and so when we talk about FDAP and the 30% withholding, I believe you said that this is gross, correct, as opposed to network.

SPEAKER_01 15:23

100%.

SPEAKER_00 15:24

So this is an opportunity, and that's why I we always say it's so important to plan in advance, right? Because one of the benefits of real estate is because when we have we have depreciation, we can accelerate depreciation, we likely will not have any tax liabilities for my investors when we consider all the write-offs that can offset those revenues. But if you have FDAP income and we haven't done the proper planning in place, you don't have the right professionals to support you in the structure, and we wind up with FDAP income. We even though you know now we have this huge withholding, it's gonna take a big chunk of your cash uh that that you have to set aside for the withholding tax, and it's gonna pretty much it's gonna restrict your ability to have that liquidity, liquidity, and working capital for your investments.

SPEAKER_01 16:11

Absolutely, and that's a fantastic point, too. And really, and we'll get into it in more detail. Really, there's a special to mention now, there is a special uh election that's available in the code to make sure one of the real threshold questions that comes into play from an ECI versus FDAP perspective, why I wanted to spend a decent amount of time on it at the outset is based on the slide here, in regards to non-residents investing in real property, owning real property in the United States that's generating current income. One of the threshold considerations that always comes into play when a non-resident is generating current income from a real property investment in the United States is look under US standards, does the non-resident's level of involvement with the real property rise to a level sufficient for it to be treated as a US trader business, be able to be treated as effectively connected income, be able to offset deductions, credits, uh, expenses as a result? There's an election available under section 871 D for individuals, Section 882D for corporations to automatically treat income generated by American real property as effectively connected income. You have to make the election on a timely filed return or on a return within the statute of limitations for the refund. Property must be income producing for the election to be made. You can't have a property where, say, it's an investment property now, you're incurring expenses, but not generating income. You're not able to make the election in that case. There are specific items uh excluded from this election as well. They're usually the ancillary income items that are associated uh with income with real estate investment. One of the ones I mentioned here, dividends paid by a corporation investment invested in American real property at the end of today's program when we discuss uh strategies for ownership of American real properties. That becomes a very pertinent consideration. And we'll go back to that. Here's some more information on how you make the election itself. Uh 871-10 D12 of the regulations has the information that's needed on this statement that you include with the tax return where you make the election. And it's really giving the IRS a full picture of any improvements of the real situation with the property so that an appropriate tax base can be determined for the property itself. Now looking at the provisions that come into play on disposition of a US real property interest. So now we're not looking at current income, we're looking at what occurs when a U.S. real property is sold by a non-resident. There are special provisions in the U.S. code, the U.S. uh foreign investment in real property tax act of 1980, I believe, is when the uh provisions were first enacted, if memory serves me correctly, is codified in section 897 of the code. The section 897 dictates that gain from disposition of a United States real property interest by a foreign person is automatically classified as effectively connected income and is automatically subject to tax as a result. Let's go back juxtaposing the two categories. When you're looking at FDAP income, like we talked about before, it's a catch-all for US sourced income items aside from capital gains. If you sell a US rural property interest, that's going to be generating capital gains income that wouldn't be captured by the FDAP category. The other main category to capture taxable income for a non-resident, like we talked about previously, is the ECI category. The non-residents' activities in mere passive investment, say in a US real property interest, say it's not income producing. Say they just own a passive U.S. interest as a family vacation home in the United States. Those activities aren't profit-oriented, they're not regular, substantial, and continuous within the United States. As a result, and here's my cat saying hello to us again as a result of that. You will not have a US trader business under uh statutory standards. What Section 897 does, and again, it goes back to the idea of the US prioritization in any country's prioritization of uh income tax, of capturing income tax with real property within its borders. Section 897 gets enacted to make sure that even irrespective of the usual capital gain exclusion that applies to non-ECI, non-effectively connected, non-business items of a non-resident US real property that's sold by a non-resident will automatically be classified as ECI and will automatically as a result be subject to tax. Now, the fact that it's classified as ECI can be beneficial in certain circumstances, like Mark referenced in the ordinary income category. Say you have you purchase a US real property for a million dollars, you sell it for a million two. You can offset the 1.2 million in gain with the 1 million purchase price. You're not looking at it, say, from like an FDAP perspective, where you have a flat 30%. Rate of tax. You're taxed at graduated rates. You can be subject if you purchase for a million dollars and you sell for $800,000. You're not going to be subject ultimately to any tax on the American side. There can be withholding requirements which come into play here, though, like I mentioned here on this slide, and we'll go into in detail momentarily. It's really when you look at the two tax mechanisms from an American perspective, those being the uh ECI and FDAP tax mechanisms, ECI, very similar to how US taxpayers are taxed, graduated system, voluntary tax returns, the FDAP system being a gross-based system with withholding as the mechanism for tax collection. The FERPTAP provisions are a really interesting combination of the two, insofar as you're taxed at ordinary income rate, or I apologize completely, you're taxed automatically on the gain at capital gains rates, subject to deductions, to credits, to offsets for basis, whole nine yards. However, one of the ways that tax and by default, an automatic tax collection method is imposed under FERPTA via withholding. And that withholding occurs by the transferee of a US real property interest. The withholding occurs. Let me see if there's anything that I want to do. This just really covers who are actually, you know what, let me trace it piece by piece. Actually, Section 897 generally is applicable to any type of non-resident, non-resident alien individuals, non-resident corporations, uh, foreign partners of a partnership can be liable for their prorata share of U.S. real property, interest gain, foreign estates, and trust are also subject to FERPTA. They're treated as non-residents for income tax purposes. One special provision that I note here in regards to let's look at flow-through entities on the American side, a flow-through entity being a disregarded entity, a partnership, some type of non-corporate entity where all of the income tax attributes automatically flow through to the underlying stakeholders. If you have a non-resident of the United States, non-resident individual, let's say who establishes a disregarded entity in the United States, she's the 100% owner. She's the 100% owner of that disregarded entity. That entity, if it holds a US rural property interest and sells the U.S. rural property interest, that entity will be subject to the FERPTA provisions, including the FERPTA withholding, that we'll discuss momentarily.

SPEAKER_00 24:53

And uh just to throw something in there, now we still can when we think about capital gains, what can we do to mitigate or eliminate capital gains? We still have the 1031 exchange. Foreigners can do the 1031 exchange. You can also do it if you do it though, I'm pretty sure we would double check. Um, you will you will have to do a 1031 exchange for another US source property. Now, let's say you don't do a 1031 exchange, there are complications, especially with syndications. Um, you will you may want to do a drop and swap or what's called a tenancy in common to allow you to exchange your interest in one piece of real estate for another, uh to roll it over. It can get a little bit tricky there. So um, other things that we can do to mitigate the tax liabilities when we do these transactions and if we sell, if you are continually investing and you buy another real estate, uh, another real estate invest in another real estate. Sorry, fumbling on my words, cost segregation, fantastic way to uh to also create right off to offset any liabilities created from capital gains. Lots of planning that we can do to mitigate the tax liabilities from dispositions.

SPEAKER_01 26:05

Absolutely fantastic. Now getting into what does or does not constitute a US real property interest. There's really two prongs to it. First is very straightforward, a real property in the United States is a real property interest, is a United States real property interest. And the FERPTA rules are applicable, excuse me, to any disposition of a United States real property interest. The FERPTA rules also apply to what is called a United States real property holding corporation. That's a United States, it's a domestic corporation where more than 50% of the corporation's assets are United States real property interest. Any US shareholder uh selling shares, disposing of shares of a corporation must establish that the corporation was at no time a U.S. rural property holding corporation during the shorter of, and there's my cat making some slide changes. She wants to move on with the next slide. I'm not ready yet. A US shareholder, any US shareholder who's uh selling a uh stake in a corporation has to establish that it is not a US rural property holding corporation during the shorter of the taxpayer's holding period in the interest or the five-year period ending on the date uh the taxpayer disposes of the interest. If it is, then it can be the sale of the uh property can be uh subject to FERPTA of the US real property interest if it is so classified. U.S. real property holding corporation, important to mention there are a number of ways to basically cleanse an entity of US real property holding corporation status prior to a sale to make sure that you're not subject to FERPA when you dispose of the stock. If a US real property holding corporation sells all property in a taxable transaction, i.e. it's actually subject to tax, U.S. real property interest status of the corporation will cease at that point because it's really the United States goal is to make sure they're capturing all uh taxable income from a United States perspective. Once they've done that, there's no need to maintain the status as a U.S. real property holding corporation. So that status does cease. Disposition, uh, some background here on what a disposition is for FERPT purposes. Any transfer that would constitute a disposition for any purpose of the internal revenue code reaches beyond just mere sales and exchanges. Any disposition, though, by a foreign corporation is of a foreign corporation is not subject to FERPT, even if it's holding more than 50% U.S. real estate. What I mean by that, let's give an example so it's not to confuse the audience. Let's say we have non-resident uh individual A, B, C, and D. They own 100% of US corporation E. U.S. corporation E owns entirely real property that's located in the United States. If A, B, C, and D dispose of their shares of the uh US corporation, that US corporation absolutely can and there will be classified as a US rural property holding corporation based on the US RPHC definition. If we change the example ever so slightly and make it so the corporation E is a foreign corporation, then that sale would not be subject to FERPTA, even if foreign corporation E holds 100% US real estate. A holding corporation can only be a US real property interest if it's a United States corporation. Any foreign corporation will not be classified as a U.S. real property holding corporation. Do mention here as well, in regards to real estate, if you have always an important consideration, anytime a non-resident sells a home that she's used as a personal resident residence. Let's say you have non-resident or US green card holder, lives in the US from 2015 to 2020. 2021, she gives up her green card. 2022, she sells her old US home. That is subject to those Section 121 exclusion of up to $250,000 of gain for a primary residence of $500,000 for gain if you are married filing jointly, although uh most often non-residents and anyone who's filing as a non-resident cannot file married filing jointly. So you're usually, from a non-resident perspective, looking at the $2,000, $250,000 exclusion. But that absolutely is available for non-residents. Non-residents, I also note here, they're not subject to FERPA on disposition of a partnership interest directly. But section 864C8 can subject them to effectively connected income tax on the disposition of that interest in basically a backdoor way. 864C8 is a new code provision under the 2017 Tax Cut and Jobs Act. So it became effective in 2018. It's codification of the service's position regarding a non-resident disposing of a US partnership interest or any partnership interest, actually. Basically, what you do is you keep the general flow-through concept and you look at the extent under 864 CA, you look at the extent a uh non or any partnership was engaged in a US trade or business. And then essentially, and it gets a bit more complex than this, as you as you might anticipate, but essentially what you look at is you make that determination, the pro-rata or the extent to which the uh non-resident the non-resident is treated as engaged in a US trader business through the partnership activities. And then say if the partnership is 70% of its activities or constitute a US trader business, then 70% of the disposition price, the disposition gain will be taxable by the United States. Now, in terms of the withholding obligations that come up under FERPTA, and these are the ones, these are the provisions that are most often associated with FERPTA generally. Section 1445A requires the transferree of a United States real property interest to dispose to deduct and withhold a tax equal to 15% of the amount realized on the disposition, unless there is an applicable exception. The amount realized for these purposes is the sum of the cash paid to the transfer or the fair market value or other property of prop or other value of property transferred to the transfer or and the outstanding amount of any liability assumed by the transfer or you aggregate all three of those numbers, and the transferee then has to withhold at 15% of that number. So let's say, for example, it let's go back to the example I gave before. Uh million dollar purchase price on a property, $1.2 million is the sales price. Uh the transferee has an automatic and uh March, let me know if my math here is wrong, it would be a 180. Assuming that there is no liability on the property, the withholding amount is $180,000 at a $1.2 million purchase price. That's almost the entirety of the non-residence tax, or it could be actually depending on improvements, things like that, it could significantly exceed actually the entirety of the non-residence tax liability to the United States. Let's change the example. Let's say uh let's go to the second example that I gave previously: $1 million uh purchase price, $800,000 uh disposition price. So you're selling it at a loss at an $800,000 disposition price. There is still going to be a withholding of $120,000 on that sale, even though the non-resident ultimately is not subject to tax from an American perspective. So it's a hugely, hugely negative result to be in that situation where you're selling a property at a loss and under statutory US provisions, you're also subject to significant withholding on that sale. The primary, there's a multitude, or there's a number, I would say, of exceptions that can apply to FERPTA withholding. The primary exception, the one that I personally most often utilize, and the best one I certainly think that's out there is in regards to what is called a withholding certificate. Basically, what you do here, revenue procedure 2000-35 outlines the requirements, outlines the protocol that you use for a withholding certificate. You basically reach an agreement with the internal revenue service prior to the sale occurring. You want to have an agreement in place anywhere from 30 to 90 days, I would say, before the sale, uh, to ensure that, hey, if you're going to be subject to withholding on a sale that's greater than what your ultimate tax liability associated with that sale would be, then it allows the transferee to withhold at a reduced rate, or potentially, if there's ultimately going to be no liability to not withhold at all. Basically, what you're looking at under section 14 to 45A is the transferee has a requirement to withhold, then transmit the withheld amounts to the internal revenue service via form 8288 is the form that you utilize, the 8288 forms. You utilize that, and I believe the 8288A also gets included with a uh filing with the withheld amount once that gets transmitted. When you're looking at a transmittal of withheld funds that exceeds the amount of taxable gain that the taxpayer would have, what the taxpayers are required to do is go in the year afterwards, file a tax return, and claim a refund for the overwithheld amount. Obviously, it's much, much more appealing to not have to go through those hoops, to not have the delay from a time value of money perspective of having the Internal Revenue Service hold your funds for can often be over a year without you having access to those funds with you having to claim a refund on overwithheld amounts. Very often, your best route is to get the withholding certificate in place, just because there can also be headaches associated with filing an actual tax return itself as well. Mention uh now on my end from an estate tax perspective, because it's another huge consideration that comes into play for non-residents making uh investments in U.S. real property or transfer tax considerations. A non-resident is subject to estate tax by the United States on any property, whether tangible or intangible, CITUS within the United States. You look at CITUS rules to determine uh where a property is going to be treated as being located. These determinations can get complex with certain assets, say like stock in a corporation, intangible assets can be complex. Real property is rarely, if ever, complex as to where it's sitist. Real property is cited in accordance to where the assets are physically located. Say you have a property in Miami that's a U.S. real property for transfer tax purposes. If you have a property in Mexico City, that's not a U.S. real property. You're looking at properties within the 50 United States or the District of Columbia are subject to United States transfer tax. The reason this gets a ton of attention is in regards to uh non-resident transfer tax planning generally, I mean gets a ton of attention is given the uh significant disparities in exemption amounts available to United States taxpayers and to non-residents. United States taxpayers currently receive a lifetime exclusion of, I believe it's $11.58 million. So it's about 21.23.2 apologies for a married couple gets during their lifetime for the vast majority of folks that's going to allow them to pass their estates entirely free of tax. There's been with the 2020 election coming on the American side, there's seems to be a good amount of momentum to lowering that exemption back down even to $3.5 million moving forward. However, currently, it's a huge, huge exemption that's out there for American individual taxpayers. Non-resident individuals receive a comparatively minuscule exclusion. Their exclusion is merely $60,000 on the estate tax side. I break down the numbers, how they work from a tax perspective. Here, you get taxed essentially $345,800 on your first million sixty thousand after accounting for the exclusion of U.S. CITES assets, then you're taxed at a flat 40% rate above that number. Say you have $5 million in US assets at the time of your death. If you're holding them in your individual name, if you have individual ownership of those assets, you're creating close to a $2 million transfer tax liability from an American perspective. Gift tax, you uh non-residents transferring a United States real property interest will also be subject to gift tax if that real property interest is actual real property located in the United States. Gift tax, the big change from an estate tax perspective, is the scope of tax. Gift tax does not target intangible assets, it only targets uh physical assets located within the United States, either real property or uh tangible personal property, say cash, hard currency, citizen in the United States is subject to gift tax. So if you have a US real property uh located in the United States, if you make a gratuitous lifetime transfer of that property to uh a child to any other party, that transfer is also subject to gift tax. The way we get around that, and here's uh more information, I'll go to this slide momentarily actually. The way we get around the transfer tax exposure, and it's absolutely critical and it's a foundational consideration for anyone who uh any non-resident investing in USID real estate and US assets generally is in regard, is a foundational aspect to it, is making sure you're not creating estate tax exposure or any type of transfer tax exposure. And the best way to do that is through by investing through some sort of separately taxable, non-individual foreign entity. Say if you set up a foreign corporation, say you have non-resident individual A owns Miami rural property that's worth $5 million. If she dies with that real property in her name, she's going to be uh subject to a $2 million US transfer tax. If instead she were to own that US real property through a foreign corporation or through a foreign non-grantor trust, some type of foreign entity that's separately taxable from an American perspective, she is not subject to US transfer tax on that transfer because what she owns directly in her name is stock in a foreign corporation. That's a non-U.S. SIDIST asset. As a result, she's not subject to transfer tax on that asset, even if the foreign corporation owns entirely US real estate. Foreign corporations uh definition definitionally are not ever subject to transfer tax. So you can easily insulate yourself from transfer tax requirements just by making an investment properly through a US or through a foreign corporate entity through some sort of separately taxable foreign entity structure. To mention here now the final part of today's program. And I'll get through this in a couple minutes so we can address any questions that are there as well. See a couple there in the uh panel that I'm seeing non resident real estate investment structuring. Anytime you're talking about non resident investments in the United States, there are a few uh there are a few primary considerations income tax consequences, estate and gift tax consequences. When you go outside of the tax realm, Two other very important considerations are anonymity and simplicity of the structure, minimization of filing requirements. The latter is fairly straightforward, self-explanatory. You want to have a fairly, especially if you're making your initial investment, initial endeavor in the United States, having a straightforward ownership structure can be appealing, both because it reduces cost associated with the structure. Very often, non-residents making initial US investments are investing smaller amounts to basically dip their toe in the water before becoming engaged in full-time US real estate investment activities. It allows for reduced cost. It also makes things more straightforward, both from a management perspective, from a compliance perspective, whole nine yards. It's very appealing to have a straightforward structure. Anonymity comes into play in regards to taxpayers not wanting to reveal their personal identity to the United States government. Mark can talk to this, I'm sure, even better than I can. If you have the non-resident investor, not I will mention on my side as well, from a multinational perspective, non-resident individuals who are earning effectively connected income, like I mentioned before, subject to tax at graduated rates, the way they pay their tax is by filing a tax return with the United States. A non-resident individual files a Form 1040 NR. A non-resident corporate entity files a form 1120F. That if they file that form, they disclose their identity, disclose their address, whole nine yards. Very often, taxpayers are concerned that if they file a tax return in their individual capacity in the United States, they're risking the United States digging into their uh worldwide activities and they're potentially risking uh complexities from the United States government, the Internal Revenue Service in particular, that they don't want to have to deal with. So it's one of those things that gets very important when you're considering how to invest. Mark, anything on your end? Mark, you're on mute.

SPEAKER_00 46:16

Right. So, and this has become a bit of a more appealing structure in the recent years. As we know, with the Tax Cut and Jobs Act, we have a 21% flat corporate tax rate that makes it much more appealing. Also, with the Tax Cut and Jobs Act, as we know, that we can only deduct 10 per uh $10,000 when we have a flow-through entity of that uh state and local taxes. But if that income is within a corporation, we can deduct all of our state and local tax obligations against federal income. And so, also when we think about these branch taxes, which can be pretty pricey on top of the 21% capital, uh 21% um flat rate right there. Um, there are other ways that we can use that money and take it out without just paying that dividend tax. How can we do this? We can borrow from the corporation, is one method. Uh, we can borrow some of that capital uh and use that to for other business endeavors, and that's a way that we can actually um activate that capital uh as opposed to just to distributing it and incurring that that hefty branch profit tax.

SPEAKER_01 47:23

Absolutely. On mine, uh totally, totally agree. And those are some of the foundational considerations when you're looking at how to invest in the United States and how to set up the ownership structure. The most straightforward option that you have is individual ownership of an income generating. Uh let's call it for purposes of illustration. Let's assume the American real estate investment here is income generating, individual ownership or ownership through some sort of look-through structure, whether a disregarded entity, partnership, what have you, whatever the case may be. The benefits that you can see here, the same the sale on disposition is subject, like we talked about before, that's capital gains income. It's subject to capital gains rates. The US rate of tax for capital gains income currently for individuals ranges between 0% to 20%. Most often it's 15% or 20%. Like Mark mentioned after 2017 Tax Cut and Jobs Act, there was a reduction in the rate of corporate tax to 21% from 35%. Corporations aren't subject to capital gains tax. They're not subject to a differentiation, I would say. They're subject to a 21% rate of tax, irrespective of the of whether the income is ordinary or capital gains. So with the lowered corporate tax rate, the paying tax at individual capital gains rate is less of an appeal, but it's still a marginal appeal, a marginal benefit that is out there. Detriment, the primary detriment here is the enormous estate and gift tax exposure that you have. You also need to file individual tax returns if you're generating current income that you're treating as effectively connected income. Do mention here as well. And it's one important thing to mention, always to keep in mind for non-resident investors, whether it's in U.S. real property interest or generally, if you have a non-resident investor who's just generating FDAP income, if they're not engaged or treated as engaged in a US trade or business, they will not have to file US tax returns. If all of the uh tax requirements from a United States perspective are properly collected through withholding at the source, there's no US tax return filing requirement, which can be very appealing for non-resident investors who are looking to engage in US investments. The ability, say, in uh private equity in uh that realm in that area. One of the things that we often talk about are uh blocker entities essentially setting up some sort of corporate structure to make sure that the non-resident investors who are usually investing in that realm private equity, there's my dog saying hello uh in the uh non-resident realm when you're investing in the United States in some sort of US private equity structure. Let's say having a blocker entity overseas blocks the income from flowing through to the individual, blocks the individual from having effectively connected income, and potentially having to file a US tax return. Second option for ownership is ownership through a foreign corporation. Biggest benefit as compared to the first example is it gives you that uh protection from a transfer tax perspective. You're also subject to corporate tax rates on ECI uh income, which can lower the uh effective tax rate when you look at it from an ordinary income tax perspective. And there are moving parts here all over the place. I'll try to keep it as straightforward as I can. But when you've got current income that's being earned by a US rural property investment, individual ordinary income rates range from 0% to 37%. Very often, or most US individual income rates are over 21%. Corporations are taxed at a flat, non-graduated 21% rate of tax under current US law. That means as a result, very often your current income earned from a real property investment can be taxed at a lower effective rate by the United States if the ownership is through a corporate entity. One thing I do want to mention here as well, when you're looking at what I always look at from my perspective, I know I speak for Mark on this, and I speak for anybody who's really working from a multinational perspective, or I should be speaking for anyone who's working from a multinational perspective. The goal here is always to create the lowest cost overall from a global perspective, the lowest tax cost for the client. There are what are called foreign tax credits. If you're a non-resident paying tax to the United States, very often, depending on your jurisdiction, you're going to be able to offset much of the foreign country tax by virtue of foreign tax credits for the tax you're paying to the United States, where these really the differentiations come most importantly into play on the American side in the ownership structure, is where the American side tax exceeds the residence country taxation. So say if you're being taxed by your home country at a 25% rate of tax and you can lower the US rate of tax from 20% to 15%, then that's not as big of a deal because irrespective of that lowering, you're going to get, whether it's 15 or 20%, you get a tax credit or in your home country for that amount, assuming that you do, you're not going to be as concerned to the American tax consequences. And quite often you can, as a result, end up prioritizing things like the uh anonymity whole nine yards. Juxtapose that with a situation where, say, you live in a country, if the US effective tax rate is 25% and you live in a country where the effective tax rate would be 35%, then lowering that US effective, or I apologize, I I do have I have that backwards. In my head, I apologize. Say it's 25% is your US tax rate, 10% is your home country tax rate, lowering the US tax to 15% is hugely advantageous because that's going to lower your global effective tax rate to 15%. The biggest detriment of the foreign corporation approach is actually what Mark mentioned, is in regards to branch profits tax. You're exposed to branch profits tax as a second layer of corporate tax on imposed just on a foreign corporation. It's essentially done to replicate a non-resident setting up a US subsidiary. You're treated as, and it's actually worse, the branch profits tax. Anybody who's interested in the branch profits tax, I have a couple of, or I have an article that I've wrote for tax notes, which is one of the big US side tax publications a couple of years ago that I'd be more than happy to circulate. It's a pretty uh narrow topic, I guess I would say, as to how it applies. One thing to mention, though, it does. It's it's something to very much keep on your radar. This is something though, where income tax treaties can come into play to lower the rate of effective tax on setting up a branch or on conducting US activities through branch operations. The my favorite ownership structure, I would say, from my perspective, is uh the what we call the corporate corporate approach. It's ownership of an income-generating American real estate investment through a foreign corporation, which itself is owned by a United States corporation. Benefits, protection from estate and gift tax exposure is still there because you have a non-resident who owns uh shares in a foreign corporation. Non-resident owns foreign corporation, foreign corporation owns US corporation, U.S. corporation owns the target investment. They're also here under this structure. There's no branch profits tax because the branch profits tax is really meant to capture tax in situations where you have a foreign corporation that is not separately incorporated within the United States. When you set up a separate US corporation, you automatically avoid branch profits tax. You don't have to worry about that under a structure where you set up a US corporation. You're also not subject to FERPTA under this approach when you have a US corporation because a US corporation is the entity selling the property. So, particularly for US real estate, I really, really, really like the corporate corporate approach. The other option that's out there that also is very appealing is a foreign non-grantor trust. And that can actually be uh more appealing depending on what the individual's uh investment goals are. It gives you the same protection from estate and give tax exposure. You don't have branch profits tax because that only applies to foreign corporations rather than any other type of foreign entity. Detriment, you are subject to FERPTA here. There are also uh negative consequences to any US beneficiary of a foreign non-grantor trust. So now with that with that being the case, Mark, Mark, you go ahead. You're first.

SPEAKER_00 57:05

So for some in the audience here, especially beginning investors, when you hear about all these percentage taxes, when you hear about the you know the 30% branch tax on top of the you know the 21% flat tax rate, how does it make sense? Well, we also want to consider before we consider all the other, there's tons of strategies, and we don't even have enough time to go into all of them, um, how we can mitigate that. But also when you look at the way that we report uh with these real estate investments on paper, right? Um, even if you have a cash flow positive asset, we have this thing called depreciation, right? As I was talking about earlier. Uh, and we can best leverage and utilize depreciation and cost segregation to accelerate depreciation to make it so in almost always in about close to 100% of the tax returns I've seen for real estate investments, there if these investments will operate at a loss, even if they are sound investments, the depreciation will offset any revenues. Uh, the depreciation combined with all the other write-offs. So there should not, we should not see that. Now, when we think about cost segregation and we utilizing bonus depreciation to have that upfront, that that that high, those all those increased deductions for depreciation, it may result in uh in some state tax liabilities because some states will not recognize bonus depreciation. However, uh some states like Texas and Florida have no state tax, and states typically will have well, I've never seen a state with a higher tax rate than our marginal federal tax rates. So we're still gonna be uh put ourselves positioning ourselves um to take advantage of all the the strategies that we know of that are beneficial for real estate investors are still gonna help you out um in spite of all these uh these additional things that we have to consider uh and potential tax consequences when being foreign investors. Absolutely.

SPEAKER_01 59:04

Now I see a question here, checking the questions from the audience. A question from Johnson Huang. Hello, I am a Canadian and I'm interested in investing into a US real estate syndication. I plan to buy units of the LLC through an LP to avoid double taxation in Canada. What is the best strategy to avoid withholding tax? Could I claim depreciation to reduce taxable income to zero and eliminate withholding, assuming after I get an ITIN? If you're looking at it, a lot of this, a lot of the ramifications. And the first thing to think about on the American side always is if you're interjecting a foreign entity into the ownership structure, how that foreign entity is going to be classified for American tax purposes. I do a lot of work with Canadian investors, Canadia or Canadia, yeah, Canada, Mexico, and the UK are probably the three uh I work most, my practice is global at this point, but those are the three that I really work the most often with on my end uh from a Canadian perspective, when you're looking at entity classification, the per se corporations on the Canadian side, the i.e., the types of entities that are automatically classified as corporations for American tax purposes, are companies and corporations. Any type of entity that is neither designated as a company nor corporation under uh Canadian rules, under Canadian corporate rules, is generally going to be able to elect its American classification. It's required to make that election within uh 75 days of the entity becoming relevant. Otherwise, it makes a prospective entity classification change, however, that being said, and then it's that may or may not be harmful uh to make a prospective change depending on what the assets are, depending on whether there's built-in gain. Essentially, the entity classification change can but will not necessarily create uh recognition of built-in gain. So you're best off making the entity classification election initially at the time of relevance. What I what ultimately where that's important from our perspective is treatment of the LP, determining how the LP is going to be looked at on the US tax side, and then looking at the four investment structures uh in that context. If the uh LP is regarded as a passer entity for American tax purposes, you're going to have essentially this ownership structure that's on the screen now, the individual uh ownership uh or through a disregarded entity, because if the LP is disregarded, you have no separately taxable entity in the ownership structure here, assuming that the LLC is taxed as a pass-through for American tax purposes, which is usually going to be the case when you're looking at a real estate syndicate uh investment. If you have purely pass-through uh transactions, this is going to be what your ramifications are. If you're instead looking at the entity uh as a the LP rather, as a corporate entity for American tax purposes, you have these ramifications. You're going to prefer these ramifications because certainly, as a prerequisite, you always want to have some sort of uh corporate separately taxable entity in the structure to avoid uh tax consequences. Really thinking it through and to get to the crux of your question regarding avoidance of withholding. The two times at which withholding can occur are in regards to uh I am blind a current income that's being earned, say rents that are being received. There can be withholding on those rents if payable directly to a non-resident. There can also be withholding under FERPTA at the time of disposition of a real property interest. When you're looking at the former category, the current income, usually the most straightforward way to avoid withholding is to make the election, uh, to treat the income as effectively connected, to supply the withholding agents with the pertinent information that you're making the election to be taxed uh at a graduated basis as effectively connected income on rental income, on income associated with the property, because then the withholding uh requirements come into play under FDAP income. You're not going to have those same withholding requirements for effectively connected income. On the sale of the property, typically the best way to avoid a withholding obligation is the withholding certificate that I mentioned before. Go to the IRS, get a determination, be proactive about it, figure out how much the tax liability is going to be. And then from there, you can get an idea of hey, this is the amount I'm going to pay to the government and not have an over-withholding occur as a result. Mark, anything on your end on that?

SPEAKER_00 1:04:21

No, I think that was a pretty thorough answer. That was great.

SPEAKER_01 1:04:25

Terrific. Yeah, and that's the only substantive question I see, unless anybody has anything else. I know we're right about at uh closing in on time today. So any of uh any additional questions that we can field by all means, although certainly I always tell people with any program, uh, anytime I can help part of my practice means having a uh blank, I apologize, is being available 24-7. So I've always got to keep myself available anytime I can assist, formally or informally. I saw a couple emails come in already, so I'll be getting in touch with anybody sending emails uh anytime I can assist again, formally or informally. Always my pleasure, and thank you so much to everybody for their time today. Mark, I'll throw it back to you.

SPEAKER_00 1:05:10

Yeah, okay, fantastic. Well, uh, whoa, whoa, sorry. Um, so I um so Patrick, that was wonderful. I really appreciate your insight. So this is a this is um a lot of information we got here, and uh I want you guys so this I will be some putting the recording, I will email it to the attendees once I complete the recording. Uh it's gonna be on my YouTube page and on my website. So if you want to re watch the material, also Patrick, I can if anybody reaches out or if you want to put your contact information in the chat, we can also see it in the slides what your contact information is. If you want to follow up with me or Patrick, lots of opportunities and considerations with planning here. Um, so Stay in touch, and you know, if you have any follow-up questions, you know, we will be more than happy to discuss them with you. And Patrick is a fantastic resource, he has been uh phenomenal helping me out. Some of you CPAs listening. Um, Patrick does lots of free CPE as well. Uh, that's how I found him. And uh, he's a fantastic resource. Uh, you guys know how to contact me for anybody who doesn't have my contact information. I'm putting it in the chat. Marketmarkpearlberg CPA.com. Uh, and stay tuned. I'm gonna email you. My upcoming webinars are all gonna be fantastic. Um, some stuff for beginning business owners and investors, and we're gonna keep things lively and fun and and just try to add as much value to all of our listeners as possible. Um, so that's all I got. Patrick, thank you so much for coming, and thank you all for listening and who will be listening in the future. I really hope you guys got a lot out of this. Uh, keep in touch, lots of great stuff to come. Uh, Patrick, anything else from you?

SPEAKER_01 1:07:01

All said on my end. Y'all have a pleasure. Absolute pleasure. Oh, y'all have a good one, absolute pleasure being here.

SPEAKER_00 1:07:07

All right, thank you, everybody. Have a fantastic rest of your day. Hope you learned a little and keep us in mind that we'd all love to help you out with your future investments endeavors.