Tax Alert on Real Estate Sales by Foreigners

Posted on Wednesday, June 27, 2018

The IRS recently issued a two-part warning concerning certain real estate transactions. The warning focuses on the tax law provisions for sales of U.S. properties that involve foreign individuals and entities. Specifically, the transactions involve: 

The disposition by a foreign person of an option or contract to acquire a U.S. real property interest. (According to the IRS, a U.S. real property interest includes options or contracts to acquire land or land improvements and leaseholds of land or land improvements.)
The disposition by a foreign corporation of a U.S. real property interest by way of a transfer to a shareholder.

Background: If a foreign person sells or exchanges U.S. real estate property and a taxable gain is realized, it must be reported on a U.S. tax return. However, it is the buyer -- not the seller -- who must withhold and then remit 10% of the real estate's purchase price to the US. Treasury. It is also the buyer's responsibility to determine if the seller is a foreign person or not.

Major Trend:
U.S. Home Purchasing by Foreigners

    Investing in real estate in foreign lands is becoming more popular worldwide. Factors such as low interest rates, soaring appreciation on home sales, affordable airfares and unimpressive stock  market returns have caused many foreign investors to turn toward real estate in the United States.
    There are no official figures kept on foreigners buying property across the U.S. But the National Association of Realtors conducted a survey of home buying activity in Florida by international investors. 
    The survey, released in 2005, revealed that 15% of home buyers in Florida were non-U.S. residents. The survey defined these individuals as those who principally reside in another country, and are not classified as a foreign-born resident of the U.S. While international real estate buying in Florida came from more than 100 countries worldwide, the majority were from Europe (58%) and Latin America (29%) including South America, Central America and the Caribbean).
    The majority of foreign home buyers purchased a single-family detached house or a townhouse that cost between $100,000 and $400,000. Most buyers said the properties were vacation homes or rental property investments. Approximately 36% paid cash, rather than financing with a mortgage.

If the seller is, in fact, a foreign person and the buyer fails to withhold or pay the 10% tax, the buyer is the one who is liable for the unpaid tax. Frequently, real estate professionals who buy property come across sellers who claim to be from the U.S., but aren't. This can put them in a compromising situation.

The other type of transaction targeted by the IRS involves transfers of U.S. properties to foreign shareholders of a foreign corporation. The IRS describes a situation where the shareholders receive the property from the corporation and sell it to a third-party buyer. Then, the shareholder erroneously claims that the gain is taxed at the maximum 20% capital gains rate. The 20% capital gains rate only affects singles with taxable income above $425,800, married joint-filing couples with income above $479,000, heads of households with income above $452,400, and married individuals who file separate returns with income above $239,500. 

In other words, the foreign shareholder claims the transfer of the U.S. property interest by the foreign corporation to the shareholder does not result in a corporate level tax. In fact, the IRS says the transfer should be taxed at the corporate tax rates, because it is a taxable sale by the corporation.

The corporate tax rate on these sales may be much higher, unless the company qualifies for reduced withholding.

Be forewarned: Don't enter into any real estate transactions without your legal and tax advisers at your side.

Posted in Tax Topics For Individuals

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.