Over the last decade we have seen a significant increase in foreign investment in U.S. real estate. With recent real estate crowdfunding options in the marketplace, it clearly makes sense that certain non-resident investors are considering crowdfunding equity investments. Let’s examine many of the tax considerations that will impact these foreign investors as they venture into this area.
As a general rule, non-resident investors must consider the following:
1. They will need to consider the best entity structure for their real estate crowdfunding investments. This includes determining whether their interest is held individually or through an entity like an LLC or corporation.
2. Even if no tax is due, they will generally be required to file a U.S. tax return and in many cases a state tax return.
3. If title is being held individually, they will need an Individual Taxpayer Identification Number (“ITIN”). This is merely a tax processing number that is issued by the IRS to international folks who have a U.S. tax filing requirement.
4. If investors do not visit the U.S. at all they will normally only be taxed on U.S. source income generated from their real estate investments. But if they decide to stay in the U.S. for extended periods they may find themselves being taxed on worldwide income, so they need to be careful.
5. Investors must consider how a certain U.S. tax structure impacts their tax situation in their home country.
6. Profit distributions are subject to U.S. foreign withholding requirements unless an exception is obtained. In addition, many states have withholding requirements as well. This means that an estimated tax will be withheld by the partnership entity and will be credited to them when the required tax return is filed.
7. In addition to federal and state income tax considerations, investors must also consider U.S. estate and gift taxes.
8. The U.S. tax code establishes certain “default” rules for non-residents. But the U.S. has established tax treaties with many countries that can alter the default tax treatment.
Individual Ownership vs. Entity Ownership
Many non-resident investors hold title to crowdfunding real estate interests as individuals. In this situation, they may find themselves taxed similarly to U.S. individuals. Income tax rates in the U.S. range from 10% to 39.6% based on an individual’s taxable income. As a result of depreciation expense, rental real estate activities can often generate passive losses and many non-resident investors will find themselves paying at the lowest tax rates. When a syndication property is sold for a gain, it is subject to the long-term capital gains rate of 15% (subject to certain exceptions).
However, non-resident investors may find that it is beneficial for them to hold title in a corporation (either foreign or U.S. based), limited liability company (“LLC”), a trust, or even a partnership. In most cases, individual ownership or ownership through an LLC taxed as a disregarded entity will result in the lowest income tax liability. However, depending on the investor’s situation, a different structure may be beneficial as a result of estate or gift tax issues. The advantages and disadvantages of each structure should be carefully analyzed with a tax professional who understands tax planning for non-resident real estate investors.
Obtaining an ITIN
In many situations, a foreign investor will obtain an ITIN when a tax return is filed. However, as a result of withholding requirements, real estate crowdfunding organizers will be seeking an ITIN upfront. The foreign investor will then need to obtain the ITIN prior to filing a tax return. Form W7 and proof of identity will need to be submitted. There are many documents that can prove identity, but the most common is your passport. In addition, the non-resident must include a copy of the section of the partnership agreement that displays the partnership’s employer identification number (EIN) along with demonstrating that they are a partner in the partnership that is conducting business in the U.S.
As discussed previously, tax treaties between the U.S. and certain countries further complicate the situation. Under these tax treaties, residents of foreign countries may be taxed at different rates, or in some situations be exempt from U.S. income tax on certain income they receive from U.S. sources. Tax treaties can and do vary extensively between countries. Additionally, the U.S. has tax treaties in effect for certain countries that cover estate and gift taxation.
Tax issues facing non-resident investors can be complex. Non-resident investors in U.S. real estate must ensure that they are dealing with a tax professional who understands the tax issues they face. Advice and guidance on tax planning initiatives is critical before investing in real estate crowdfunding.