Foreign Buyers Guide
Foreign Nationals are allowed to own real estate in the US. In fact, there are very few differences between a foreign and US buyer when purchasing real estate. It is important that the Foreign Buyer understands the Buying Process and knows some basic information about general US real estate practices that may vary greatly from a buyer’s home country.
- US Practices
Transparency – In the US, real estate is very transparent. A new listing for sale is required to be posted to the listing service within 24 hours so that active listings are available to all agents. This is unlike in many other countries, where buyers have to go from agent to agent to find a property. We have access to all the listings in New York and Florida and can assist you in the sale of any one of them.
Commissions – The sales commission is always paid by the seller (and then divided equally between both the buyer’s and seller’s brokers), so buyers don’t pay anything to have a buyer’s agent working on their behalf. It is always advisable for a buyer to work with an Exclusive Buyer’s Agent who will protect the buyer’s interests in the transaction.
- Issues for Foreign Buyers
Foreign buyers are generally prohibited from buying Coops
Coops generally prohibit foreign ownership. Coops usually require a buyer’s source of income to be from the US and assets to reside in the US (at least the bulk of the assets). Coops require this because they are ultra-conservative corporations and, if for whatever reason the corporation had to sue an owner, it would be very difficult to be successful in the litigation. Even if the corporation obtained a judgment against a foreign owner, it would likely be unenforceable if the owner’s assets were sitting in another country 4,000 miles away. Accordingly, Foreign Buyers are restricted to buying Condos (Condominiums), Condops (Coops with Condo rules), and Townhouses. Buyers, however, have more rights when buying a Condo, Condop or Townhouse than when buying Coops, which are very restrictive on the use of the property. See Determine the Type of Property to Buy for more information on the differences between these types of properties.
Financing is Readily Available for Foreign Buyers
During the financial crisis, Foreign National financing dried up. However, over the last couple of years, banks have loosened their restrictions on Foreign National financing. Most qualified Foreign Buyers can obtain financing for properties with a 30% down payment. Here are the terms of HSBC’s Foreign Buyer program as of Q1 2014:
Depending upon how long you think the holding period will be, you might want to go with an adjustable-rate mortgage that matches the holding period and has slightly lower rates. While banks are offering loans to Foreign Buyers, they require a long-term relationship with the customer beyond just the mortgage. That is why they require as one of their terms that the buyer hold the $100,000 deposit with the bank. While this is just one example of a Foreign National mortgage program, we have access to an array of mortgage brokers that suits the needs of a Foreign Buyer. Some of our mortgage broker contacts work with small banks that have very competitive terms and more flexibility than the big banks. Let us know if you want further information on this subject.
- Income Taxes
Foreign Buyer Must “Elect” to Pay US Income Taxes on Net Rental Income
The US government requires that the Foreign National “elect” to pay US income taxes on any net income (rental revenues less expenses) derived from rental property. If this election is not made in a timely fashion (e.g., US income tax returns not filed), a tax of 30% of the gross rental income will be assessed. Under this scenario, the investor would not be able to deduct any expenses such as depreciation, interest, property taxes, common charges, etc. Even if the Foreign Investor is incurring tax losses in the beginning years of their investment, and, therefore, doesn’t owe any taxes to the government, they still must file their tax returns in a timely manner in order to make the election.
No Income Tax For the First 10 to 15 Years When Financing Real Estate Purchases
Foreign buyers who finance their purchases with a 40% to 50% down payment will likely not pay income taxes on the net rental income for the first 10 to 15 years, since the US government is very generous when it comes to those expenses that are allowed to be deducted from rental income. Since mortgage interest, common charges, property taxes, depreciation of the asset over 27.5 years, insurance, and amortization of closing costs are all deductions against income, in the early years the property will generate negative taxable income. In future years, when the apartment is generating taxable income, such income can be offset by the prior year’s negative taxable income (a.k.a. tax loss carry forward). This results in no income taxes for many years. See the Cost Components of a Real Estate Investment section of this website for further information.
Foreign Buyers Should Consult with Their Home Country Tax Specialists
A Foreign Buyer’s overall tax liability may be different than that of a US resident depending upon the buyer’s home country’s tax treaty with the US, if any. Therefore, it is best to consult a local tax advisor that is familiar with the tax treaty. For instance, the capital gains rate for US residents is 20% (if the property was owned for more than one year). Foreign Nationals, however, could be required to pay a higher rate, depending upon their home country’s tax treaty with the US and how they structure their purchase. A local tax lawyer who is familiar with your home country’s treaty would be the best resource for answers to these questions.
- 1031 Exchange
Foreigners can Defer Capital Gains Taxes by Buying Another Investment Property
The US government allows Foreign Sellers to use Section 1031 of the IRS Code to defer capital gains taxes. The rules are quite complex and one must not stray from the rules, otherwise the transaction won’t qualify for deferral. To learn more about this topic, click here.
Foreign Investment in Real Estate Property Tax Act (FIRPTA)
When a non-resident sells US property, the Internal Revenue Service wants to be sure they get paid capital gains taxes. Accordingly, the IRS withholds 10% of the gross purchase price of the property. When a US tax return is submitted reporting the capital gains tax, if there is any refund due, that money will be refunded to the filer.
- Estate Tax
Foreign Buyers Must Plan to Avoid the US Estate Tax
When a Foreign Buyer dies, his or her estate will be taxed by the US government at close to 46%. This is easily avoided if the Foreign Buyer does some upfront planning. The planning involves setting up a Limited Liability Corporation (LLC) and a Foreign Corporation. The LLC would own the property, the Foreign Corporation would own the LLC, and the buyer would hold shares of stock in the Foreign Corporation. Under this scenario, since the property is “owned” by the Foreign Corporation, the US government would receive nothing upon the death of the Foreign Buyer. This is a great tax savings for Foreign Buyers and is not very expensive to implement. This structure also allows for the easy transfer of the property from one party to another by the selling of shares of the corporation rather than the sale of the property, which might trigger a taxable event. It is advisable for any owner of investment real estate (foreign or US) to create at least an LLC to hold the property, since using this structure limits the owner’s liability to the value of the LLC, which would strategically own only that particular property and, therefore, the owner’s liability would be limited to the net value of the property. Taking this one step further, using a Foreign Corporation to own the LLC would provide protection to the Foreign Buyer against the estate tax. If a Foreign Buyer does not want to maintain the LLC and the Foreign Corporation (perhaps because the investment is small), an alternative approach would be to obtain life insurance in the amount of equity in the property. For example, a 38-year-old man in good health would pay $1,300 per year for a 10-year term life insurance policy paying a death benefit of $1,000,000. While the Foreign Buyer would not avoid the estate tax, his or her heirs would receive the same amount in the case of death.
Our team of real estate agents, attorneys and CPAs have in-depth knowledge about each of the issues facing Foreign Buyers. We are here to educate our Foreign Buyers on all of the consequences of a real estate purchase.
- Closing Transaction
Foreign Buyers do not have to be in the US to Close the Deal
At the closing of the transaction, when the property is transferred to the new owner, the new owner does not need to be in the US. Rather, the new owner can provide his or her representative with “Power of Attorney” and the representative will have the right to close the deal on behalf of the new owner. This is quite common and convenient for the buyer who does not want to come back to the US for the closing.
- Property Management
Because the vacancy rate in Manhattan is only 1.5%, the tenant will pay our commission — 15% of the first-year annual rent. Only in Manhattan, tenants are competing against each other to find apartments. Elsewhere, in other states, owners compete against each other to find tenants. Accordingly, in other states, the owner will pay the fee, usually 10% of the annual rent.We want to work with our clients for the long term — sourcing properties for our buyers, sourcing tenants annually for the apartment rental, and at the end of ownership, listing for sale and selling such property. As an inducement to accepting this arrangement, we offer “Property Management Light” at no charge. Here is how it works:
Generally, we don’t handle cash. Rather, we manage the process to fix the problem. We also don’t collect rents or pay bills on the owner’s behalf, as this is usually done through electronic banking, which you as the owner will have to stay on top of. If you desire to hire a property management company to handle cash collection and disbursement, we can refer you to a few companies that do that, but they charge a significant amount to do this annually, which eats into profits. Most of our clients prefer our Property-Management Light option which doesn’t cost them anything. Many of our clients are investors, so we have a lot of experience in this area.