Global Head of Cross Border Wealth Planning, Citi Private Bank
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The structuring of US real estate ownership can have a profound effect on non-US individuals' tax situation.
The vast majority of individuals who purchase real estate do so in their individual name. However, this is often a big mistake for non-US persons buying US property as it will be fully subject to US federal estate tax.
The way individuals structure the ownership of their US real estate can have a profound effect on their tax situation. The form of ownership may drive income and transfer tax consequences, liability risks, privacy levels, and the need for probate after life.
Although owning US property in an individual’s personal name is the simplest way to hold it, it can ironically create the most difficulty from a tax perspective after the individual’s death. US federal estate tax is currently 40%, which can make for a significant bill. State-level taxes may also be levied in addition to the federal tax. In the State of New York, the additional estate tax on real and tangible personal property located in New York, which exceeds the basic exclusion amount (currently $5.25 million), ranges between 3 and 16%.
Non-US persons are subject to US federal estate tax on US situs assets worth more than $60,000. As many non-US persons have recently invested heavily in US property – particularly in major metropolitan cities – it is something most non-US individuals need to consider.
There are a number of strategies to avoid a potentially large estate tax bill. These include holding real estate in a Private Investment Company (PIC), an irrevocable trust, or a combination of both.
Historically, individuals have bought US property through a limited liability company (LLC) structure, for privacy reasons – as the property would go in the corporation’s, not the individual’s name – and also avoid substantial withholding taxes upon sale of the property.
In some cases, individuals would not treat LLCs as corporations, but as disregarded entities, which meant gains were subject to individual tax rates. As of last year, that would mean the client would pay 20% in long-term capital gains tax rather than being subject to a maximum 35% corporate tax rate.
However, the US’s decision to cut corporate tax rates from a maximum 35% to a flat 21% in December 2017 has made the two taxes virtually identical. This means that PICs – which are subject to corporate tax – may become more popular as the difference in tax levels becomes less significant.
That said, however, it is important to note that there are a number of different factors that need to be considered when assessing different forms of property ownership. It would not be wise to make a decision solely on tax liability.
Careful planning should be carried out prior to a purchase to maximize the tax efficiency of an individual’s intended purpose and take into account their priorities and circumstances. Individuals should consult their legal and tax advisors to decide the appropriate strategy to achieve their objectives.