Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property – Part III

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INTRODUCTION

This is the final article in a three-part series that explains U.S. taxation under the Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”). This article looks at certain planning options available to taxpayers and the tax consequences of each.

These planning structures aim to mitigate taxation by addressing several different taxable areas of the transaction. They work to avoid gift and estate taxes, and double taxation of cross-border events and corporate earnings, while simultaneously striving for preferential treatment (e.g., long-term capital gains treatment), as well as limiting over-withholding, contact with the U.S. tax system, and liability. Often, such structures are helpful in facilitating inter-family transfers and preserving the confidentiality of the persons involved.

PRE-PLANNING

As with everything else, planning can go a long way when it comes to maximizing U.S. real estate investments. Here are a few questions to ask:

Investor Background

1. Where is the investor located?
2. Where is the investment located?
3. What kind of business is the investor engaged in?

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property - Part II

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This article examines the U.S. income, gift, and estate tax consequences to a foreign owner upon a sale or other disposition of U.S. real property, including a sale of real estate, sale of stock of a U.S. corporation, or a sale of a mortgage secured by U.S. real property.

In addition to (or sometimes in lieu of) rental income, many foreign investors hope to realize gain upon a disposition of U.S. real property. The Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”) dictates how gains are taxed from the disposition of United States Real Property Interests (“U.S.R.P.I.’s”). The law has a fairly extensive definition of U.S. real property for this purpose. Most significantly, the law provides for a withholding mechanism in most cases.

WHAT IS A U.S.R.P.I.?

A U.S.R.P.I. includes the following:

• Land, buildings, and other improvements;
• Growing crops and timber, mines, wells, and other natural deposits (but not severed or extracted products of the land);
• Tangible personal property associated with the use, improvement, and operation of real property such as:
• Mining equipment used to extract deposits from the ground,
• Farm machinery and draft animals on a farm,
• Equipment used in the growing and cutting of timber,
• Equipment used to prepare land and carry out construction, and
• Furniture in lodging facilities and offices.
• Direct or indirect rights to share in appreciation in value, gross or net proceeds, or profits from real property;
• Ownership interests other than an interest solely as a creditor, including:
• Fee ownership;
• Co-ownership;
• Leasehold interest in real property;
• Time-sharing interest;
• Life estate, remainder, or reversionary interest; and
• Options, contracts, or rights of first refusal.

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property - Part I

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INTRODUCTION

U.S. real estate has been a popular choice for foreign investors, whether the property is held for personal use, rental or sale, or long-term investment. Since the passage of the Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”), the governing tax rules have developed and evolved, but have not succeeded in discouraging foreign investment. F.I.R.P.T.A. can be a potential minefield for those unfamiliar with U.S. income, estate, and gift taxation – all of which come into play. This article is the first of a series on understanding U.S. taxation of foreign investment in real property.

TAXATION OF A FOREIGN PERSON

“A foreign person is subject to U.S. income tax only on income that is characterized as U.S. source income.”

As simple as the concept sounds, there are applicable nuances, caveats, exemptions, and exceptions. Therefore, several questions must first be answered to determine the U.S. income tax consequences for a foreign person engaged in U.S. economic activities, including ownership of real property:

1. Is the income derived from a U.S. source and therefore potentially taxable?
2. Is the income taxable or exempt from tax?
3. Is the income passive or active, subject to a flat withholding tax on gross income or, alternatively, to graduated rates on net income?
4. Is the income earned by an individual or corporation or other entity, each of which may have different rules and applicable tax rates?

Inbound Investment in German Real Estate

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INTRODUCTION

Investments in German real estate are attractive to international investors. Low interest rates and positive economic conditions exist in Germany. The demand for commercial and residential rental properties has increased in urban centers such as Berlin, Düsseldorf, Frankfurt, Hamburg, Cologne, Munich, and Stuttgart. In these circumstances, it is expected that Germany will remain an attractive market for real estate investments.

Germany provides reliable political conditions, which are advantageous for a successful investment. However, there is an increasing complexity to the general legal conditions, and the success of a real estate investment strongly depends on proper structuring of the investment in a tax-efficient way.

This article provides an overview of the tax consequences of inbound investments in German real estate.

Different investment structures are compared:

• Holding the property directly,
• Holding shares in a property company, and
• Holding interests in a property partnership.

In addition to income tax, German real estate transfer tax aspects are discussed, and planning opportunities to reduce or eliminate German trade tax are explored.