By:Augusto Egoavil, Partner & Director of the LATAM Practice Group
Non-resident alien individuals and foreign corporations are treated differently than United States tax residents for purposes of U.S. federal taxes.
U.S. Taxation of Non-Resident Alien Individuals
U.S. citizens are subject to federal income taxation on their worldwide income, no matter where in the world they reside. U.S. resident alien individuals are treated like U.S. citizens, unless they can claim to be treated as non-resident aliens.
Payment of certain categories of passive income to non-resident aliens, known as fixed or determinable annual or periodic income (“FDAP income”), is subject to withholding tax at source on the date the to the non-resident alien individual is made. Absent any income tax treaty between the United States and the country where the beneficiary is a resident, FDAP income is generally subject to a 30% withholding tax. If the tax is withheld as provided by law, the nonresident alien individual is not required to file a U.S. tax return to report the income. If the withholding does not reflect the taxpayer’s actual tax liability, the non-resident alien individual is required to file a U.S. tax return to report and pay the additional tax due. The withholding agent can also be penalized for an erroneous withholding. There is no withholding tax required if the FDAP income is treated as income effectively connected with a U.S. trade or business.
Non-resident Alien Individuals and Foreign Companies Owning U.S. Real Property Interests
When dealing with payments of rent on real property to non-resident alien individuals, the tenant is required to withhold income tax at the rate of 30% on the gross amount of rent so paid. Most tax treaties do not include real property rent as subject to a reduced tax withholding rate.
Non-resident aliens are not typically subject to U.S. taxation on capital gains except for the sale of real property in the United States under the Foreign Investment in Real Property Tax Act (“FIRPTA”). Gains or losses of non-resident alien individuals or foreign corporations from the disposition of a U.S. real property interest are taxable as income effectively connected with a U.S. trade or business. The tax withheld is credited to the amount of federal taxes owed by the seller on its tax return. The withholding tax applies to the sale of real property by a non-resident alien individual, a foreign company, or a domestic partnership owned by a non-resident alien individual.
Disposition of Real Property Interests by Non-resident Alien Individuals and Foreign Corporations
When a foreign person is selling real property, it must analyze if the transaction is subject to FIRPTA or if it falls under some exception from withholding or if it can apply for a tax withholding certificate. The amount that must be withheld from the disposition of a U.S. real property interest can be adjusted pursuant to a withholding certificate issued by the Internal Revenue Service (IRS).
A foreign corporation that holds a United States real property interest from a country with which the United States has in income tax treaty, is entitled to nondiscriminatory treatment and can make an election to be treated as a domestic corporation for purposes of tax withholding.
Sale of real property by a partnership
If a domestic or foreign partnership with any foreign partners disposes of a U.S. real property interest at a gain, the gain is treated as effectively connected income and generally is subject to the rules explained above. A foreign partnership that disposes of a U.S. real property interest may credit the taxes withheld by the transferee against the tax liability determined under the partnership withholding on effectively connected income rules
If a foreign partnership disposes of a U.S. property interest, the transferee must withhold taxes, unless the transfer is exempted from withholding or the transferor obtains a withholding certificate.
The buyer of the real property or its agent must find out if the transferor is a foreign person or subject to tax withholding under FIRPTA. If the transaction is subject to tax withholding and the transferee fails to withhold, it will be held liable for the payment of the tax not so withheld.
A withholding certificate may be issued due to: (a) a determination by the IRS that reduced withholding is appropriate because either: the amount that must be withheld would be more than the transferor's maximum tax liability, or withholding of the reduced amount would not jeopardize collection of the tax, (b) the exemption from U.S. tax of all gain realized by the transferor, or (c) an agreement for the payment of tax providing security for the tax liability, entered into by the transferee or transferor.
Federal Estate and Gift Taxes
Ownership of real property interests by non-resident alien individuals can subject them to gift and estate taxes on any inter-vivos or post-mortem transfer of real property situated in the United States. Non-resident aliens are exempt from gift and estate taxes up to $60,000. Careful planning is required to structure the acquisition of real property by non-resident aliens. The same concerns apply when the real property is owned by a domestic company owned by a non-resident alien individual.
Ownership of U.S. real estate by foreigners still is attractive regardless of the difference in tax rules applicable to the ownership of such assets by non-resident or U.S. citizens or residents. However, there are several structuring alternatives that can be considered as owning the real property by a foreign company or to enhance the acquisition by interposing a domestic company. Domestic companies can be used in an effective way and depending in the circumstances the ultimate owner of the real property may use a corporation or a partnership or other types of structures that can foresee different taxable events in an efficient manner. In all events, non-resident individuals and foreign companies should always consult with their tax advisor before acquiring real property. Although in some instances, structuring can be done thereafter, it is not that efficient.
Should you have any questions or desire further insight, feel free to contact one of the members of our Tax Department: