Type of Entity to set up when buying property in the US from overseas

A while back, I attended an American Chamber of Commerce Breakfast Meeting in Seoul. At that meeting, the speakers gave information on the best entity structure to use when investing in the US from abroad.

I took notes during the presentation and I've written them up below.

Please note that I don't know if my notes are 100% accurate or up to date. Please consult an entity specialist for advice. I'm not a legal professional, and I offer my notes as-is and based on what I believe to be true. This might be a great place to get started if you're still figuring out the process. But definitely look for other sources online or consult with a professional for further details.

FIRPTA - Foreign Investment in Real Property Tax Act

FDAP - rent, dividends, etc. aka withholding tax

ECI - Effectively Connected Income

AMCHAM Real Estate Chair - There’s lot of liquidity in international capital markets. Where’s the best place to invest?

Kwon Lee

Mayer Brown HK Managing Partner

  • Most popular tax structure for outbound investments (out of Korea) - K Trust Structure

Jason Bazar

Tax Transactions and Consulting

  • The US is not a tax friendly jurisdiction. Without proper planning, an investor can end up paying a 60% effective tax rate. But that can be brought down to 15% with property planning.

ECI (for foreigners with a physical presence)

ECI (Effectively Connected Income) = Income tax

  • for corporations - up to 35%

  • for individuals - up to 39.6%

US Trade or Business must be ‘effectively connected’

 

FDAP (for foreigners without a physical presence)

Collected by the payor (one who is distributing funds to its investors)

  • Withhold up to 35%

No US Presence. Withholding is applied to the gross income, not net income.

 

Portfolio Interest Exemption

To qualify, one must:

  • own less than 10%

  • not be a bank

  • other requirements

In which case you can lower your withholding to 0%

 

Branch Profit Tax

Basically to equalize FDAP for foreign corporations

  • Withhold up to 30% of distributions of dividends

According the US / Korea Treaty, Branch Profit Tax can be 0%.

However to qualify for this, the Foreign Entity must file a US Tax Return. Then (see FIRPTA re: US Income Tax Returns and why foreigners may want to avoid that).

 

Capital Gains

  • Stocks / Bonds - Don’t pay Cap Gains on disposition

 

FIRPTA - Foreign Investment in Real Property Tax Act

Taxation on the income from the disposition of US real property interest

Some people tried to dodge this requirement by buying shares in a corporation that held US property. However IRS closed that loophole by adding:

  • Includes sale of corporations whose assets include 50% of real estate property

The BUYER of the property must withhold 10% of the GROSS price of the purchase. In order for the SELLER to get that money back, SELLER must file a US Income Tax Return. In which case, the SELLER is basically announcing to the IRS that they exist and open themselves up to an investigation into all US income that the SELLER may earn.

 

REIT

  • Withholding dividend 10%-15% (10% with US Korea Treaty)

  • No corporate tax - save 35% (if you own more than 10% of the REIT)

  • Less than 10% of the REIT = 35% Withholding

Value of a REIT investment = if you’re investing for cashflow and not for appreciation

 

Typical Entity Structures favored by Foreign Investor

1. Foreign Investor -> US Blocker -> US Property

US Blocker

  • Might include a Nevada C Corp or Delaware (entity) or LLC with a special exemption that allows it to pay corporate taxes

  • Blocker pays US Income Tax - 35% Federal Income Tax

    • But it’s Net Profits

  • No Branch Profit Tax

But at disposition, US Blocker must pay 35% Tax (However, no additional tax if US Blocker is liquidated)

2. Foreign Investor -> Leveraged US Blocker -> US Property

Leveraged US Blocker

  • With this strategy - also get interest deduction

3. Foreign Controlled REIT

Foreign Held REIT

  • Strategy is for income producing properties, not appreciation plays

  • No Corporate Level Taxes

  • All income must be distributed

  • 10% Withholding rate for Koreans

  • REITs must have 100 shareholders or more

  • Must hold REIT for 2 years or more

  • Subject to FIRPTA at Disposition

4. Domestically Controlled REIT

Foreign Investor -> JV (other US investors) -> REIT (needs 100 shareholders)

Domestically Controlled REIT

  • Foreign Investor must own less than 50% of the REIT

  • However, there are ways to structure management to not lose control of the investment

  • No tax on disposition

State and Local Taxes

  • All have their own separate rules - Transfer taxes, recording taxes, etc.

FATCA

  • Used to track down non-US taxpaying citizens

  • Basically anyone who accepts US investment money must comply with FATCA and turn in a form

  • Helps IRS keep track of US citizens who are investing abroad

Using Korea Trusts as a structure to invest in US Taxes

  • 10% vs 15% according to the US Korea Treaty

  • Not written in stone but seems to be the general consensus

 

Let me know if any of this information seems to be in error in the comments below.

If you're an entity specialist and would like to talk to our group about the best way to invest in US properties while living abroad (for a retail, not institutional investor), then please feel free to reach out and let us know.