What Foreigners Need to Know When Purchasing Property in the U.S. | PREI 025
In this episode we talk to Chris Picciurro, the co-founder of Integrated Financial Group, about the many important tax-related topics related to investing in the United States as a foreign national. There’s a lot to consider from withholding taxes, tax reduction strategies and asset protection. This episode is full of great content and a must listen if you’re an investor from any country outside the U.S.
His contact information is:
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What Foreigners Need to Know When Purchasing Property in the US with Chris Picciurro
Welcome to Passive Real Estate Investing. I’m your host Marco Santarelli. I just finished recording an interview with a very knowledgeable CPA who’s the co-founder of Integrated Financial Group, and what we discussed is taxes. But don’t let that turn you off. Taxes as it relates to foreign national investors. If you are looking to invest in the United States or you have been investing in the United States, you’ll definitely want to listen to this episode.
Chris specializes in taxes for non-resident and non-US citizens that are looking to buy or are already purchasing investment property in the United States. He has some great advice. We stopped to look at estate taxes, withholding taxes, how to structure your entities. Now this is not case specific. We had to be somewhat general, but there’s so much great content.
I hope you get a lot out of this episode as we talk to him about purchasing property here in the US. I hope you find this episode informative because tax laws can be complicated but it really comes down to a case by case basis. Stay tuned.
It’s my pleasure to welcome Chris Picciurro. He is the Executive Officer and Co-founder of Integrated Financial Group. This guy has a list of credentials longer than my arm. I’m just going to highlight some of the stuff here. He has over 15 years’ experience as a CPA, including an adjunct instructor at Davenport University. He’s an Accounting Instructor with an MBA program, I think I got that right. He’s a graduate of Michigan State University. Has an MBA from the University of Detroit. He is extremely knowledgeable when it comes to taxes, especially as it relates to foreign investors. His list goes on and on. I’m not sure what this means but Chris maybe could tell us a little about it, Rich Dad Educational Events. Anyway, Chris, welcome to the show.
Hi, Marco, it’s good to talk to you again. How are you?
I’m doing fantastic. I’m excited to have you on the show here because we work with investors not only around the United States but around the world. A lot of them come from Canada, Australia, England, we have some people from Japan, so it varies. I know you can talk a lot about taxes as they relate to citizens within and outside the United States. But for today, at least, I want to put more of a focus on taxes as they relate to foreigners investing within the country. That’s framing this episode. Let’s start off by talking about where you’re located. Maybe you can explain this Rich Dad Educational Event.
Our headquarters is in the Detroit Area, outside of Detroit, Michigan. Although the scope of our practice is not only throughout the United States but it’s throughout the world. We specialize in assisting non-US residents that buy investment property here in the United States. We have been very fortunate to work with clients in over 40 different countries at this point and our client base spans over 30 US States as far as where these investments are taking place in the real estate and property management professionals that we work with also.
When I say that we help US non-residents that invest in the United States, I mean that we help them with their tax planning, their tax preparation, consulting as far as what type of entity they should be and consulting as far as estate tax. That is the focus of our organization.
As far as working on the Rich Dad Events, we have been a part of discussing asset protection and tax planning for not only US residents that buy investment property here in the United States, but also non-residents that attend the events. We’ve had a great time attending those events and being able to talk about our piece of that puzzle for an hour to an hour and a half at various locations in United States and we’ve also done that internationally.
It’s a great time. I have a passion for traveling, a passion for real estate and I just happened to be decent at doing numbers. That’s how I got into this business. I think if you have a passion for something, even if it’s not your core competency, you can figure out a way to parlay your core competency into doing things you find fun.
You’ve been doing this for over 15 years. Obviously it’s something you enjoy and know well. There’s a lot of misinformation out there I think with investors. We get questions from our clients from time to time about whether they should set up this type of entity or that type of entity within the US, how to hold title, the tax implications. We don’t get into tax and legal advice. We always refer them to professionals like yourself or have them talk to their own tax and legal advisers. A good percentage of our foreign investors come from Canada and I know there’s differences between one country and another as it relates to the US. I think the best place to start is at a high level and maybe you can start up by telling us what foreigners need to consider when they’re purchasing US based real estate.
We have several clients from Canada. We’ve been all over the place there, meeting with property owners and prospective property owners and we surely enjoy meeting our neighbors from Canada. In fact, one of our offices in the Metro Detroit Area is right across the river from Canada. We do a lot of work with the Canadians.
What makes things interesting for investors is that we have to look at a multitude of factors to assist them in coming up with a strategy for structuring their investment. Some of the things they can control, some of the things they can’t control.
Let’s first, from a 30,000 foot view, look at the United States tax rules for rental income for a non-US resident. Unfortunately, our tax code calls these folks “non-resident aliens.” We don’t like to use that term. We’d like to use the term “foreign national.” We have something called FIRPTA in this country which was enacted in 1980. To make a long story short, it’s just a law that dictates the tax collection for income related to rental, rental income and the dispossession of rental property. It also pertains to other types of income. For the purpose of this podcast, we’re going to focus on that.
What FIRPTA says is that if you’re a foreign national or a non-US resident and you have an investment here in the United States in real estate and that real estate produces income, whoever the property manager is or whoever your paying agent is; it could be a realtor, it could be a property manager, is required to withhold 30% of your gross rental income and send it into the IRS. You, as the foreign national, need to file a tax return at the end of the year and attempt to get that money back.
What we do for our foreign nationals is, through structuring into the planning, we make sure we don’t pay the 30% gross income tax. Yes, there might be some income taxes to pay here in the United States but those tax rates are very low compare to other countries. That’s why investing in the United States is attractive to many foreign nationals. Also, if structured properly, due to the Canadian-US Tax Treaty, an investor will avoid double taxation, which means quite simply, if you’re a Canadian and you have to pay some US tax here on your rental income, you get a credit for that tax in Canada and you don’t have to pay the tax twice and vice versa.
Canadians thinking about investing in the United States have to think, “I don’t like having to pay 30% of my gross income in a tax. I’m going to properly identify myself and structure my investment and fill out the proper compliance forms.” Secondly, that’s the income tax considerations, but they have to consider estate tax, they have to consider asset protection. If somebody is concerned about asset protection, which I’m sure a lot of the listeners of this podcast are and investors are. The cheap thing to do would be to form an LLC.
Unfortunately, specifically for Canadians, the Canadian Revenue Agency, not to get too technical here. We do want to keep people awake without having to get another cup of coffee. Quite simply, Canadians that are investing in the United States, if they form an LLC, the issue is at this point the Canadian Revenue Agency looks at that LLC as a corporate entity. Not a flow-through entity.
What you’re saying is they lose the ability to have that LLC as a simple flow-through entity for tax purposes, which we can do within the US as a US resident. We just flow it through to our personal tax return. But as a Canadian or maybe as another foreign national, you’re saying you can’t do that?
You’re correct. You cannot use an LLC at this point and avoid double taxation due to the CRA’s view of the LLC. Now, that puts Canadian investors in a pickle from the asset protection side of things because they can easily come here and buy the property in their own name. That’s actually the most simple way to do things, but they do lose that asset protection.
We have to talk to that client. We have to look at their time horizon, their investment amount and what their intention is for this property. Is it to be held as a legacy property for their family? To produce income for them? Is it to be owned for a short period of time and potentially flipped? Is it to be held for an intermediate period of time, potentially sold and reinvested to a new property? Something that you might be familiar with, and partake in what’s called the 1031 exchange. Meaning, you’re selling one property and buying another property for at least the same value. That gets technical, we could do a whole podcast just on that.
But the point is, get to know the clients, understand their personal situation. What their time horizon, investment amount, their intention for the property is, what their personal income tax rate is? Some factor to consider is it would potentially be their house because we also want to reduce the estate tax exposure. We just have to ask the right questions, get to know the clients and make sure that their investment in the United States real estate is structured properly. We always say, “You never let the tax tail wag the dog.” If it’s a good deal, it’s a good deal. We’re just going to make sure that their tax situation is taken care of in a cost effective manner.
Everything you’re telling me prompts to other questions. You are talking about the tax treaty that the US has with Canada. I know the US has tax treaties with other countries, other states, other jurisdictions. Is this also true for foreign national investors in other countries, whether it be Great Britain, Australia, maybe Japan? Does the same thing apply to these countries?
Absolutely. Except those countries might look at the LLCs differently. Canada is a little bit unique in that way. With the United States Tax Code, there are certain countries that we have a tax treaty with. There are certain countries that are no tax treaty countries. Depending on what country you live in or what country you’re a tax resident would affect the planning in your investment. In general, the countries that the US plays nice with, they have a tax treaty with. The countries they don’t play nice with, probably don’t have a tax treaty. That would affect withholding rates, estate planning, and like I said, a variety of different issues. It doesn’t mean don’t make your investment. Like I said, a good deal is always a good deal. Just structure it properly.
For clients that are in countries that don’t have a favorable tax treaty, what they may choose to do here is they might chose to form an LLC and make a corporate tax selection to avoid the withholding. Like I said, we’re not trying to get technical here. It comes down to knowing your clients. That’s why for folks like your clients or listeners of the podcast, we’re going to offer them a 30-minute complimentary consultation. Just to see what their situation is and what direction they should go in.
I appreciate that.
No problem. Because a little bit of time planning is going to prevent a lot of headaches in the future, potentially.
Let me drill down just a little further on the LLC topic. Not to get too granular, but I want to understand it a little better. I mentioned this to you before we started recording here. There’s a lot of different opinions out there. Let’s just call it misinformation when it comes to LLCs. For US residents, it’s a powerful tool. I love LLCs. I use them for my own businesses and my own personal holdings. But when it comes to foreign investors, foreign nationals, does an LLC make sense at any point in time? Is it a tool that they can use or should use in particular situations?
Absolutely. I would say the majority of our clients that are foreign nationals acquire property through an LLC. An LLC is what we call a boutique entity. What that means is that, there’s a ton of flexibility. There’s flexibility not only in ownership percentage in profits and management but there’s also a flexibility in how that LLC is treated for tax purposes here domestically in the United States. An LLC from a technical stand point could be taxed as a disregarded entity, if there’s only one owner. The LLC could be taxed as a partnership. The LLC could elect to be taxed, if it’s a foreign national, not an S corporation, but the LLC can be taxed as a corporate entity here, if that makes sense.
There’s tons of flexibility with the LLC. The issue specifically with Canadians is that the CRA, like I said, doesn’t look at the LLC as a flow-through entity. It treats it as a corporate entity. Marco, I’m going to send you a little bit of information on that, if you want to share with the podcast listeners. Because here’s what happens, people say, “I don’t like that answer, so that can’t be right.” But I’m going to send you some articles, some third party articles and some research that has been done and some case history on the situation. I’ll send you some links after the podcast on this.
What we do with our Canadian owners is we assess the situation. We determine if asset protection is a big issue for them. Quite frankly, if someone’s going to acquire one home that’s $60,000, I don’t know that asset protection in forming an entity is that big of a deal because they’re still going to have some type of property insurance and that’s up to the owner. You have to look at the compliance cost versus the risk mitigation versus the benefit of it.
Now, if someone’s going to invest in an apartment building or a three-home portfolio and they’re Canadian and let’s say they’re worried about asset protection, then we have a couple of options. Like I said, I’m not trying to get too technical, but there are two basic formation options. There are thousands of formation options but two basic ones, if you want to accomplish just avoiding … in one option you’re actually avoiding the FIRPTA withholding altogether but also obtaining the asset protection.
The first option would be what we call the two-tier structure where a Canadian owner forms a Canadian limited company in Canada. That Canadian limited company then purchased forms of subsidiary US corporation and the US corporation then owns the homes. The advantage of that structure briefly is that it provides you with some estate tax benefits because the property is owned by the corporation, provides the actual owners of the two corporations some anonymity here in the United States and it provides some of the asset protection because the homes are technically owned by a domestic US corporation. The two-tier structure is popular.
Then there’s the LLP structure. Since a Canadian shouldn’t own a property in an LLC, they form a Limited Liability Partnership. Now, to be an LLP or Limited Liability Partnership, we have to have something and that something is more than one owner. You have either a husband or a wife or two business partners become owners of the LLP. Thus, there’s more than one owner in this investment and then they form an LLP as supposed to an LLC.
Let’s say you have someone that’s a single person. They’re making the investment on their own. They don’t want to create a US corp but they want the asset protection. You may have a Canadian corporation or US corporation, one of the two, and you would have the Canadian individual. Those two would be partners, one a general partner, one a limited partner of the LLP. Really you’re taking one person, creating some type of entity so that you can have two owners and you get the LLP treatment.
Like I said, not trying to get too technical. We don’t want to put people to sleep here. But the point is if you’re Canadian, it’s very attractive to invest in the United States. They’ve represented for several years, this year is a little bit different because the Chinese just took over as the number one investment group in the United States by foreign nationals. But not by much larger than the Canadians. But for the last five, six years Canadians, have been the majority purchaser of US property by foreign nationals.
We’re seeing a lot of inflow from foreign capital, particularly from China. I call that Capital Flight. People are just trying to move their currency out of their own country into “safer” countries. Here’s a question for clarification. Because you covered quite a bit there. You referred to the US entity that’s held by the foreign investor as a corporation. Are you using that term in the general sense, meaning that corporation could be a corporation or an LLC here in the US? Or are you referring to the corporation specifically as a corporation?
It could be an LLC that elects to be taxed as a corporation or it could be a real corporation. From a technical perspective, a single member LLC, meaning there’s only one owner, is a disregarded entity. If a foreign corporation owns an LLC and the LLC is disregarded, then the property is just owned by the foreign corporation and you don’t have a two-tier structure anymore. The LLC would elect to be taxed as US corp, or it could be an LLC that elects to be taxed as US corp.
Some of our Canadian clients that maybe they’re buying one property, a lot of them already have a Canadian corporation established from a Canadian limited company. The reason is that the income tax rates on the Canadian limited company are a lot less than their personal tax rates. Their Canadian limited company can come in the United States and buy a property directly.
The tax rates for a foreign corporation are slightly larger than the tax rates for a US corp. But if you have one property, you might as well just own it in a foreign corporation. If you start buying a portfolio, now all of sudden we have to weigh, is the reduction of the tax rates significantly more than the compliance cost? And if they are, then it make sense for us to get fancy.
Just to help our listeners out here with some definitions. A disregarded entity is simply an entity here in the US that you don’t need to file a Federal Tax Return for. Because even though you have to file a form for it, and correct me if I am wrong, you still file a form at the end of the year, you’re not actually doing a tax return. The numbers just flows straight to you personally or the holding entity of that disregarded entity, correct?
Correct. Let’s say I form an LLC and I’m the only owner. The LLC itself doesn’t have to file a tax returns. It just goes on my personal return. Actually, I like what you said. I might steal that from you. It’s just a non-tax reporting entity. It exists for asset protection and for legal purposes of a separate entity. But for tax purposes, it’s disregarded and it doesn’t file a separate tax return.
To step back here and just to look at the bigger picture. What you’re saying is foreign investors, including Canadians and maybe especially Canadians, can hold entities here in the US and there’s a multilayer approach here. But if it’s an LLC that they are using to hold title, this is actually a question, does the LLC have to file as corporation or could it still be a disregarded entity that they hold within their LP or whatever other entity that they have in their foreign country?
Yes, it could be a disregarded entity.
I did another podcast episode on asset protection specifically. I used the analogy that asset protection is really similar to the layers of an onion. You have the asset which may be held in a trust, which may be held in an LLC, as an example. Then on top of that, you have your property insurance and then maybe on top of that you have an umbrella insurance policy. You’ve got all these layers to the onion that provide asset protection that can provide anonymity and possibly even some tax benefits. It sounds like that’s what you’re describing and it gets not so much confusing but very detailed and granular. But when you step back, really, that’s all you’re doing. It’s just you’re creating layers of protection and privacy around that asset.
Exactly. You got to weigh the cost versus the peace of mind. We have one client from Germany that they own a 135 single family homes in the United States and they are very risk averse and they decided to form a corporation. That corporation here owns 135 LLCs and each LLC only owns one home. Now that doesn’t mean you have 135 bank accounts and Federal ID numbers because each LLC is disregarded. For tax purposes, they still only file one return with all of 135 property’s performance on that tax return.
But from a compliance standpoint, every LLC you have to pay an annual fee for and probably a registered agent. Now, here in Michigan, LLCs are pretty cheap to come by. Same with Indiana and some of the other states that are out there. An LLC is only $50 a year to renew. But in taxes, that’s about $500 to form. California is $800 plus an $800 fee each LLC. It really depends on what makes feasible, economic sense for that client.
It’s ridiculously expensive in California. Which is yet another reason to add to the long list of reasons why we don’t recommend investing in California and we don’t ever offer properties here in the State of California. It just doesn’t make sense on so many levels. You keep referring to FIRPTA which, for our listeners, it’s the Foreign Investment in Real Property Tax Act. It’s just a long name for basically a tax act that defines what needs to be withheld, what the taxes are when you sell the property.
Maybe touch upon that. Talk about the withholding and, you don’t need to get into a lot of details, but just the legal way to work around that. I know you’ve touched upon that. Also, what about the sale of the property? Let’s just say five, ten years from now, you have a foreign investor who’s build a portfolio of 10, 20 properties here in the US and now they want to start liquidating it for whatever reason. What happens at that point?
That’s a great question. What happens is if it’s a non-resident of United States, they would be subject to the FIRPTA withholding when the property is sold. Ten% of the gross sales price of the property is going to be withheld for federal income tax. Now, estate taxes may apply. Obviously, states like Texas, and Tennessee, and Florida by the way that have a significant amount of investment going on in them, don’t have a state income tax. That’s a federal tax withholding. What the IRS or the government is saying here is that, “We don’t know what your profit is on this house. We’re going to keep 10% of the sales price and you could file a tax return at the end of the year and claim that back.”
If you didn’t make a profit out of it, let’s say you lost money for some reason or you didn’t make a significant profit, then you’d get some of your FIRPTA withholding back. That’s assuming you don’t do a 1031 exchange. Foreign nationals are absolutely eligible for a 1031 exchange, which is a section of the tax code that talks about exchanging lifetime property. If you sell a real property and you want to acquire another piece of real property, there are rules and regulations that apply to such a transaction. But in theory, let’s say you did that, then you won’t have to pay tax on that.
In plain English, just so everyone understands, the 1031 exchange is a tax-deferred exchange. You’re selling property, taking that equity with what could essentially be realized gains, moving it into other property elsewhere within the US and doing that on a tax-deferred basis.
Correct. You have to take the entire sales price, or you can do a partial 1031, but you are correct. FIRPTA wouldn’t apply to that. Yes, so you have 10% of your property sale withheld and then you have to file a tax return at the end of the year, which is not a big deal except for people that have been negligent. We call them ostriches, they put their head in the sand and not gotten an ITIN number, i.e. have not identified themselves here in the United States as a taxpayer and have not filed a tax return. You won’t get your FIRPTA money back.
That’s some of the misconceptions here. Foreign nationals will say, “I rented it out, but I paid my property taxes, my property manager and the kid next door to clean the swimming pool. I really have no profit and plus I never took the money out of the United States. I don’t have to file a tax return, right?” That’s not necessarily correct. They still would need to file a tax return here. If they were ever to dispose of the property, they’d be subject to FIRPTA. They would also be exposing themselves to some issues if they were to pass away and then the property goes into their estate. One of the issues most likely, and I’m not a probate attorney, but one of the issues in probate would most likely be, has this person filed tax returns? This is an income producing property.
That’s why a lot of our work actually is centered around presenting for the National Association of Realtors and National Association of Residential Property Managers on compliance for the property managers. If your property is managed professionally, your property manager should have asked you for an ITIN number and a W8 Form. If they don’t have those two things, they should be withholding 30% of your gross rent if you’re an investor.
Some of the property managers, most of them that are not in compliance with the law, I would assume just don’t know the rules. That’s why we’ve been on this renegade of educating. Some of them are ostriches. The issue here is that the United States government and the IRS, in 2010, hired 1,500 new IRS collection agents just specifically to collect on this FIRPTA withholding, on the rent. They made it a tier one issue. The IRS has since gotten away from the tiering of issues, but in layman’s term, it’s important to them.
Is this withholding only at the federal level or are there states that also have withholding laws that require them to withhold?
Great question again. That’s just the federal withholding. I know California has a withholding. In Florida, if you have a vacation rental that the tenant stays six months or less, there could be a franchise tax withholding. You have to look at the municipalities in states. Some states have tax withholding. You’d have to file to get that back. We’ve had clients come to us that they had withholding, they didn’t even see it. Maybe they didn’t read their statements. We’re saying, “Let’s go file a tax return and get this back.” No matter how good your property is producing, you’re never better off paying 30% of your gross rent in tax. You don’t get the depreciation deductions, the property management fees, the real estate taxes, the insurance, you get none of those deductions if you just accept the withholding.
You mentioned retirement accounts a little while ago. I know Canada has the RRSP, similar to the IRA in the US. I can’t remember what they call in Australia, it’s a super fund or something like that.
Yes, Super Fund in Australia. Superannuation Fund.
Different countries have different retirement accounts. I know investors can use those but from my understanding, it’s quite difficult. There’s limitations to how much of that account can be used for foreign investments and I don’t know how the taxation works. Maybe you could quickly comment on that, can they use retirement accounts and does it make sense to use retirement accounts if you’re a foreign investor?
That’s a really good question. They can use retirement accounts to buy property here. I know in the UK, they call it a pension scheme. You said the Australian Super Fund and the Canadian Retirement Plan. We have a lot of clients domestically that use self-directed IRAs to invest in property. Is it a good idea? In the world of taxation, the answer is it always depends. If you’re looking to diversify your portfolio, if you’re looking to flip homes and defer tax on it, the idea gets better and better.
Let’s talk about the US residents, tax residents first. If you’re a US tax resident, and you buy the property in a self-directed IRA, then we know that any tax in rental income and capital gains are deferred until you take the money out. I love the strategy of US residents buying property in a ROTH IRA because then it’s all tax-free. That’s just the best.
Self-directed IRAs, self-directed ROTH, self-directed SEP, solo case, any self-directed domestic retirement plan is not subject to FIRPTA. Self-directed foreign retirement plans are subject to FIRPTA. The United States government looks at that as a foreign corporation, if you will, or a foreign individual. But we could still elect out of the withholding and we would just file a tax return and they would have to pay tax on the net income.
I’m not saying it’s a bad idea to do that. If someone’s resources are limited and there’s a good deal in front of them, then do it. I always say, “Hey, 70% of a dollar is better than 100% of zero.” If you have to pay some tax, that’s okay. Yes, they are allowed here and it’s common. It’s very common, and some of the other countries that are loosening up their rules as far as taking retirement assets and acquiring property here, it’s becoming more prevalent.
On the topic of retirement, taking it to the next logical question, what about US estate taxes, gift taxes. What is the exposure to foreign investors when it comes to US estate and gift taxes, on their US real estate?
I’m going to preface this by, but a lot of the topics we’re talking about today could be their own podcast. I don’t want someone to think that I’m omitting things, just glossing over something that isn’t extremely important and it would warrant some attention and analysis. But that being said, estate tax, so obviously, US tax residents, you have a $5.4 million exemption as far as you can pass away with that amount of assets and your beneficiaries don’t pay any tax on the inheritance of an asset.
Now, obviously, if those assets are in a retirement plan or an annuity that has some taxability to it, they might pay tax on it when they take the money out. But the simple transfer of assets is not taxable. A foreign national, their exemption is $60,000, not the $5.4 million. We can creep up on that $60,000 pretty quickly.
Is that total or is that per year?
That’s for their life.
That’s a lifetime exemption for 60. Now, some countries, i.e. Canada have carved out language in the tax treaty that addresses estate tax. Even though it’s a $60,000 exemption, they can use treaty benefits and they can say, I’m going to give you an example, real easy example. Let’s say you have a Canadian owner, they have a million dollars of total personal assets, they have $100,000 of US real estate. 10% of their total assets is US real estate. In that situation, they would get a $540,000 exemption here in the United States, 10% of our domestic $5.4 million exemption. It’s not that simple, there’s a lot of paperwork that’s involved and a lot of planning that’s involved. But the $30,000 for US, if you’re in a tax-treaty friendly country like Canada, there is some relief from estate tax.
But, Marco, remember in the beginning when we touched on structuring? I mentioned the two-tier structure where you own a US domestic corp? That’s your hedge against estate tax because corporations have a going concern. A corporation is not subject to estate tax. That’s why I was saying we need to talk about our client’s health, I mentioned, their age, their investment horizons and what their plans are for the property.
There’s so much that goes into it and estate tax, especially for non-residents, is a very complicated field that warrants attention based on someone’s situation. Then you look at, “Do I form a trust? What type of trust? Do I form a trust in my country? Do I form a US trust? Are the beneficiaries US residents?” We can run into so many issues. Someone could be a US resident for tax purposes and a non-resident for estate tax. Or, Marco, someone could be a US resident for estate tax and a non-resident for income tax.
We really have to look at the situation, how much time they spend here, what their intent in the United States is. Do they even come to the United States? There’s so many factors involved that, like we said, it seems like there’s a ton of factors and there are, but with a half-hour talk with a client and doing hundreds of these tax returns, and as a company we do about 3,000 tax returns a year, we know exactly what to ask for. It’s almost like speed dating. Not that we’re rushing the clients, but we just know what to ask them.
It’s like a funnel, you know what questions to ask in the beginning and those answers are like a logic diagram, yes, no, you follow it down and you know exactly where to go, with the answer to each question. We have to do that with our clients as well, but that’s just part of the process.
In the estate tax, off the top of my head, I believe it’s 40 – 45% is the estate tax. The proper planning has to be in place. Marco, I’m going to give you an example. Let’s say you have a somewhat younger Canadian couple. They invest $200,000 here in the United States and acquire a property. Let’s assume they’re not eligible for any type of these treaty exemptions, etc. – Let’s say it’s a single person, I’ll just make it easier. They invest $200,000 in the US, they don’t have a treaty exemption. They have a bunch of property here worth $200,000 and they unexpectedly passed away. Their estate tax exposure will be approximately 40% of $140,000. Let’s just be easy and say they have a $60,000 or $70,000 estate tax exposure.
With the proper planning, we can mitigate that exposure. What that would mean is you have to look at what are called US situs assets and what are US non-situs assets. One non-US situs asset would be proceeds from a term life insurance policy. If the person’s in decent health, instead of them sacrificing all of that cash which they really don’t have because they own property here. If they don’t have a life insurance here, if they just have property here, they have no cash to pay the estate tax and the property either gets sold in a distress sale, which could still be subject to a 10% FIRPTA and it’s just ugly.
With the proper planning, for that client and that amount of investment, we might say, “Why don’t we just buy a $100,000 term life insurance policy for the next 20 or 30 years? If something were to happen to you prematurely, then the proceeds of the policy would go to pay the estate tax and any probate fees and then your beneficiaries would simply inherit the houses without paying tax. There are strategies for the $200,000 investor, the $50,000 investor, the $2 million and the $20 million investor. It just depends on the client. That’s what we have to do, we have to assess the situation.
You’re right. We could make three or four episodes out of all this content quite easily because it’s pretty involved and there’s just a lot of rules and regulations. Maybe it’s not that complicated, but when you look at this for the first time where you’re not sure what you need to do as a foreign national investor, you have to plan your things properly so you avoid taxation that you don’t need to pay, you’ve got your estate planning in place. There’s just a lot of things to consider.
The internet is an awesome resource but it’s also somewhat of an enemy because a lot of times, clients or prospective owners, they try to do some research and they take one piece of the vast IRA’s tax code and they apply it to the wrong thing. It isn’t that complicated if you talked to the right people. It is complicated if you don’t. It’s just like if my engine blows out in my car, if I roll up to Walmart and think I’m going to get it fixed properly, I’m not. But if I go to an engine repair specialist, it’s not that complicated for them. It’s simple. You just got to find the right people and do a little bit of planning and then go for it.
My last question, I didn’t really want to go down this road because it opens up a whole bunch of other questions. A US citizen living abroad, so they’re a US citizen non-resident, are they considered a foreign national investor or are they still taxed as a US citizen as if they were living in the US?
You’re right. We could have a bunch of podcasts on this one. But real quickly, a US tax resident or a US citizen that lived here, let’s use a person in the military or someone that was born in the United States, they own property here and they moved to another country. They are still a US tax resident and they’re still taxed on their worldwide income even if they … I’ve had a client retire to Costa Rica and they say, “I don’t care about health insurance because I can get whatever I need done rather inexpensively and that’s all I really care about. I want to go and be in nice weather.” If you leave the United States but you’re a citizen here and you are a resident, then you are taxed on your worldwide income no matter where you go and you still have to file US tax returns, especially if you want to ever come back here. You have to file US tax returns.
There are some tax advantages or tax benefits you could pick up, one of which would be the foreign income tax exclusion if you quality. You can even make up to, I want to say $93,000 or $94,000. I can’t remember the number off the top of my head, and not have to pay any US tax on it. That’s a foreign income tax exclusion. It’s going to apply to a lot of people in the military, government contractors that go overseas for an extended period of time.
There’s also something that’s called a foreign tax credit. What the foreign tax credit does is it gives you a credit on United States tax return for any foreign taxes that you happen to pay in another country. Sometimes that’s easy to figure out, sometimes it’s hard. We had clients that were somewhat missionaries. I can’t even remember if they moved to Egypt or somewhere in Africa. Everything was based on a cash system. We had to put together their income and I said, “How much tax did you pay there?” “We don’t know. We just had to go give them 5,000 units of whatever their currency was.” I said, “When did you do that? Then let’s come up with some type of exchange rate and try to properly file your tax return here.”
To not be considered a US taxed resident, even if you leave, you have to expatriate. Just because you moved doesn’t make you an expat. You might hear that, “I’m expat because I live on a boat floating around the Pacific Ocean or the Mediterranean Sea.” You’re still a US resident. You have to officially renounce your citizenship and your tax residency, it’s a formal process, it’s very expensive. What they do is they almost treat it like you died. They take a snapshot of your assets and you might have to pay an exit fee based on those assets.
Some of the founders of Facebook did it right before they went public. They said, “Here’s my assets today. Let’s pay the fee and let’s not be a US resident anymore and then establish residency …” A lot of people in the Cayman Islands or this and that or other thing. Those are things that we could touch on and you touched on something that we talked about in our presentations a lot. Sometimes, it’s a simple question of, what is this person? It sounds ridiculous but we have to figure out, is the person that I’m meeting with, let’s say a prospective client and we’re meeting via phone or Skype or in our office, are they a US resident for tax purposes, are they a non-resident? Are they a resident for estate tax purposes? Are they a non-resident for estate tax purposes? Sometimes, it’s a gray area and we have to figure it out and put something we can hang our hat on.
Sometimes the clients want to be one thing and not the other, sometimes they don’t want to be one thing and not the other. It gets murky sometimes but we’re always going to do the best things for our clients within the limits of the law and explain the situation to them in words that they can understand and help them.
We can go on forever, it sounds like, Chris.
Exactly. I know. I do enjoy this stuff. Maybe if it warrants the attention, we could do another podcast or someone on our team on another subject matter.
Yes, we’ll look at doing another episode on maybe US citizens living abroad or something to that effect. Just in wrapping up here, is there anything else you’d like to share with our listeners before we wrap up? Anything I should have asked you that I didn’t?
My only advice is to definitely seek some advice before you invest in the United States. It could be a very, very profitable endeavor. I appreciate the attention. I know their time is valuable. I appreciate anyone’s attention and time. If you want to contact me, I have a terribly long last name and a long email address but I’m on Twitter @picccpa. I’m there. Please reach out to me. I promise I’ll reach out back. Or you can check us out in the internet. Our website’s a little lengthy. It’s USNonResidentTax.com.
Finally, if you want, like I said, any of your listeners, we’re more than happy to give them a half-hour complimentary consultation with myself or someone way more qualified than me. Please give us a call. Bobby is our marketing director and that number is 888-434-7791 extension 202. Now, I just feel like one of those Las Vegas prognosticators that’s giving you my Monday night guarantee, get your money back, from back then. But that’s all right. We’re more than happy to help.
I appreciate that. This has been good. I’ll put your contact information in the show notes. If listeners want to give you guys a call or take advantage of that consultation, they could go ahead and do that. I think it would be worthwhile, especially if you’re already investing in the US. If you’re thinking about it, now is a good time to lay that foundation properly right from the beginning.
If you’ve already invested and you’re feeling like, “Uh-oh, I don’t like what this guy had to say.” Don’t be an ostrich, let us know. It’s better to address any exposure now instead of getting a nastygram from IRS and then having to address it.
We have a client right now in Calgary, Canada I’m sure thinking just that. “Did I start it off on the right foot? Did I put the right entity in place?” This has been great information. I appreciate your guys’ time, the information has been fantastic. I’m sure listeners will appreciate it. We’ll certainly have you back in the future here for a related topic.
All right, Marco. Thank you very much and have a great rest of the day.
You too, Chris. Thanks again, talk to you soon.
Thanks again for listening. If you have any questions about real estate or our turnkey properties, be sure to contact our investment counselors. You can go NoradaRealEstate.com or through our PassiveRealEstateInvesting.com website. Remember to subscribe. Leave us a rating and review on iTunes. If you do so just let me know through the email [email protected]. Be sure to send us your mailing address and I will drop a free mug in the mail for you. It’s our “Keep Calm and Invest On” coffee mug. I’d be happy to send you one. Thanks for listening and we look forward to seeing you on our next episode.