Since the beginning of 2011, nearly one out of every four purchasers of real estate in the Phoenix area has been a foreigner. Wealthy Chinese and Indian investors, among others, regularly visit the area, sometimes in “real estate investment tours.”
It’s not hard to see why foreign real estate investors find Phoenix attractive. The weather is near-perfect most of the year, and prices are 50%-70% below their 2007 peaks. I’ve confirmed from contacts in southern California, Las Vegas, and Atlanta that foreign buyers are very active in those real estate markets as well.
The money coming into U.S. real estate is likely to increase further if a bill recently introduced by Senators Charles Schumer (D-NY) and Mike Lee (R-UT) becomes law. The VISIT-USA Act will, if enacted, create a new visa category that grants foreign buyers of qualifying U.S. real estate a new “homeowner visa.” The minimum total purchase would be $500,000.
There are a few catches, of course. Foreign investors have to put up cash for their purchases—no mortgages or home equity loans allowed. Plus, while buyers can bring their spouse and children with them to the United States, none of them can work here without obtaining a separate work visa. Neither the buyer nor members of the buyer’s family are eligible to receive U.S. citizenship under this visa. Nor would they be eligible for any of the accoutrements of the welfare state, including Medicare, Medicaid, or Social Security.
Finally—and here’s where it gets interesting—the buyer must live in the home for at least 180 days a year. Do you hear the sound of a mousetrap snapping shut? You should, because this requirement eventually brings the buyer into the U.S tax labyrinth.
First, buyers must live in the home they purchase for at least 180 days annually to maintain their visa. Over an extended time period, this makes them U.S. tax-resident and thus taxable on their worldwide income. Under what the IRS calls the “substantial presence test,” aliens must pay U.S. tax on their worldwide income if they spend more than 183 days in one year in the United States. Yes, 180 is less than 183, but the test also applies to aliens present in the United States for at least 183 days over a two or three-year period. Without going through the technicalities, foreigners who spend an average of more than 122 days/year in the United States—including portions of days—must pay tax on their worldwide income. More favorable rules may apply when aliens can also be considered resident in a country with a tax treaty with the United States.
Second, since the buyers are U.S.-tax-resident, they must comply with all applicable disclosure rules for foreign income and accounts. Essentially, they will need to disclose every source of foreign income and every foreign account they own. If they fail to do so, they face severe civil and criminal penalties.
Third, the buyers will need to disclose interests in foreign trusts, foreign corporations, foreign mutual funds, foreign retirement and pension schemes, and virtually every other foreign entity. Civil and criminal sanctions await those who fail to comply with these obligations as well.
Fourth, the U.S. tax treatment of these foreign interests may be much less favorable than they would be in the buyer’s home country. For instance, the U.S. “controlled foreign corporation” rules may force the buyer to pay tax on income or gain that would otherwise be tax deferred. Income or gain in pension or other retirement plans may likewise be taxed, rather than deferred.
Fifth—and here’s where it REALLY gets fun…let’s say the buyer suffers a fatal heart attack, dies in a tragic accident, or otherwise sheds his mortal coil while tax-resident in the United States. That means his entire worldwide estate is subject to U.S. estate tax. The current exemption is $5 million, with a top rate of 35%, but on Jan. 1, 2013 the exemption goes down to $1 million, with a top rate of 55%.
The only saving grace of the VISIT-USA proposal is that it would provide a “non-immigrant” visa. Presumably, this would mean that individuals who obtain U.S. residence with this visa wouldn’t be subject to the U.S. “exit tax” if they stay for more than eight years, and then leave. Currently, only citizens and long-term permanent residents may be subject to this tax when they expatriate—give up their U.S. citizenship and passport, and/or their U.S. permanent residence.
Of course, foreigners can always purchase property in the United States and take care not to live in it long enough so as not to become U.S.-resident. But even here, there’s a trap. Absent a more favorable treatment via an estate tax treaty with the country in which they’re resident, the entire value of that real estate is subject to U.S. estate tax, less a $60,000 exemption. “Entire value” means any mortgage or other encumbrance on the property is ignored for estate tax purposes. That means a non-resident alien could own a $300,000 house with a $250,000 mortgage, and his heirs would be subject to estate tax on the entire $300,000. Similar rules apply to investments in U.S. banks and brokerages.
Fortunately, planning opportunities exist to deal with these problems. If you’re a foreigner and want to spend time in Phoenix or elsewhere in the United States, don’t stay long enough to be considered U.S. resident. Foreign investors in U.S. real estate should also purchase real estate through a structure, rather than in their own name. Done properly, this not only avoids U.S. estate tax, but also provides asset protection.
Confused? We can help. If you’re a foreigner considering investment in U.S. property, contact me at info[at]nestmann[dot]com (info @ nestmann.com). We can help set you up the appropriate structures to make sure you don’t get caught in the U.S. tax “mousetrap.”