The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) allows the IRS to tax foreign persons on the disposition of real property that is located within the United States. Property that is covered by FIRPTA includes any U.S. real property and includes personal property that is considered to be a part of U.S. real property (such as hotel furniture). The person that is responsible for withholding the FIRPTA tax is called the “withholding agent” and is typically the purchaser of the property. Federal law requires that 10-percent of the realized amount of the disposition. Under the FIRPTA rules, the 10-percent withholding amount is based on the amount realized by the seller. If the withholding agent fails to properly withhold the correct amount under FIRPTA, they can be liable for the tax.
Are non-resident aliens subject to the U.S. gift tax?
Yes. But unlike their U.S. resident counterparts, non-resident aliens are not entitled to the “unified credit”. The unified credit allows a U.S. resident taxpayer to give a gift of up to five million dollars without incurring any gift tax liability.
Are non-resident aliens are subject to the U.S. estate tax?
Yes. Non-resident aliens are subject to the U.S. estate tax on real property that is located within the United States. An effective exemption of $60,000 will reduce a non-resident alien’s gross estate by that amount and estate tax will be computed based on the excess.
Can domestic and foreign corporations be interposed between U.S. real property and a non-resident alien in order to avoid estate and gift taxation on a subsequent transfer?
Yes. A non-resident alien taxpayer who wishes to maintain an ownership interest in real property located within the United States without triggering an estate or gift tax upon a subsequent transfer could form and utilize a chain of domestic and foreign corporate entities. Under this strategy, the foreign non-resident investor(s) would own an interest in a foreign corporation. The foreign corporation would own all of the shares of a U.S. corporation. The U.S. Corporation would be the legal owner of the real property located within the United States.
So as long as there is no operating income at the U.S. corporation level, no U.S. federal income tax will be due until there is an ultimate disposition of the real property. When the ultimate non-resident alien investors decide to gift or bequeath their interests in the U.S. real property, they need only transfer the interest in the foreign corporation. For U.S. income tax purposes, the ownership of the U.S. real property has not changed because the U.S. corporation will continue to own the property, even if the underlying ownership of the foreign corporation changes.
Will this strategy yield any U.S. taxation obligations?
Yes, eventually. If and when the U.S. corporation disposes of the U.S. real property, it will incur a U.S. corporate income tax obligation dependent on any gain that is realized on the sale (currently taxed at 35%).
Is the U.S. corporation a United States Real Property Holding Corporation?
Yes. Under U.S. law, the domestic corporation that owns the underlying U.S. real property is a USRPHC. Under U.S. tax law, special taxation rules come into play when money or property are distributed or otherwise liquidated to shareholders of a USRPHC. Thus, if and when the U.S. corporation makes a dividend to its foreign corporate parent, a 30% withholding on the dividend will be required. That being said, USRPHC liquidating distributions (under IRC §332(a)) to another corporation are not subject to the FIRPTA withholding regime.
Can a non-resident alien utilize a foreign trust to avoid U.S. estate tax?
It depends on the type of trust used. If a non-resident alien transfers interest in real property to a irrevocable foreign trust and that trust becomes the sole owner of a domestic LLC (by transferring the U.S. real estate to the LLC in exchange for an ownership interest), U.S. estate tax can be avoided. When the LLC sells or exchanges the U.S. real estate, a 20% capital gains tax will likely be implicated. Although it is likely that there will be no estate tax upon the death of the underlying non-resident alien, U.S. gift tax may be triggered when the property is initially transferred into the foreign trust.
How should a non-resident alien structure his or her affairs in order to avoid or reduce U.S. estate or gift tax?
Although there are various hypothetical methods that a non-resident alien could undertake to reduce or eliminate their U.S. income tax obligations, only an experienced United States tax attorney can recommend an effective strategy based on the non-resident alien’s own set of specific circumstances. Planning for the future begins well before the end of a person’s life.