The frequently asked questions about buying an investment property in the USA
As UK/US ex-pat tax experts, we know that buying an investment property in the USA can be a daunting prospect. This certainly applies to many of our clients looking to buy one or more properties as investments.
The first and foremost question that many of our clients ask is ‘Can foreigners buy investment property in the USA?’ This article seeks to address that question and related topics.
It’s important to understand everything you need to know about property investment in the USA before committing time, energy and money into any real estate.
The USA property investment market bounced back in 2020 much faster than other sectors of the economy. It has sustained growth into 2021 despite the impact of Covid-19.
The pandemic has affected every sector but real estate has remained resilient. Low-interest rates have helped the USA housing market to stay buoyant.
The USA’s property market experienced a record-breaking year in 2020, with the average home selling for 8.4% more than in the previous year.
A total of 5.64 million homes were sold in 2020, representing a 5.6% rise from 2019 and the most since before the Great Recession.
The US housing market has been struggling to keep up with demand for the last 10 years, with a boom in demand in the middle of the Covid-19 pandemic.
Property sales during 2021 in the USA have seen house prices going up by double-digits, with houses selling rapidly in competitive market conditions. There is a tight supply of property on the market.
Housing supply will ramp up during 2021 and house rental prices are also expected to rise this year.
With housing shortages and fewer people buying property in the USA, we would expect to see the demand for rented property to grow.
The most frequently asked questions we get asked about from investors looking to buy property for investment in the USA include:
“Why you may be paying too much tax when investing in USA Real Estate Property.”
“Understanding the basics of buying foreign property for investment in the USA.”
“Can foreigners buy investment property in the USA?”
“Is the USA property sector a stable market to invest in?”
“What are the key differences foreign property investors need to be aware of?”
“What do I need to know about the Foreign Investment in Real Property Tax Act (FIRPTA)?”
“Can foreign investors avoid FIRPTA tax?”
“What is Withholding Tax and how much does a foreign investor have to pay?”
“What are the tax implications for foreign ownership of property in the USA?”
“When does a foreign property investor need to file a US income tax return?”
“Can I use a 1031 exchange to avoid FIRPTA and Capital Gains Tax?”
“How does this affect our UK readers?”
Why you may be paying too much tax when investing in US Real Estate Property
There are many reasons why British people living in the United States pay far more tax than they need. This is because:
-They do not know what they do not know.
-They have not spoken to a tax specialist that knows all the UK and US tax laws.
-Their accountants in the UK are not knowledgeable when it comes to the US tax laws under the IRS.
-Their CPAs are not knowledgeable when it comes to the UK tax laws under HMRC.
Understanding the basics of buying foreign property for investment in the US
As US/UK ex-pat tax experts, we know that buying property for investment in the US needs to be handled thoroughly and professionally for foreigners.
To understand the basics of buying property in the USA for British ex-pat clients, it is important to first gain an understanding of the overall USA housing market before investing in any properties there.
The real estate market in the USA has been exceptionally active throughout the Covid-19 pandemic.
Although millions were laid off or furloughed, it didn’t prevent house hunters from buying homes across the USA. As a result, the housing market saw the highest sales growth since the unprecedented housing boom in 2005.
The current housing boom has been driven by high demand and record-low mortgage rates in the USA.
Both of these factors have been because of the pandemic. The housing market has seen record-breaking growth since June 2020 with prices continuing to grow despite an ongoing economic recession.
The USA rental market has seen a surge in demand during 2021. This is a positive sign for foreigners looking for property investment opportunities. This is despite Covid-19 lockdowns and job losses.
The IRS has produced a helpful guide for non-resident aliens and real estate investment which is worth reviewing.
We also recommend that you speak to a transatlantic tax expert before investing in property in the USA.
Can foreigners buy investment property in the USA?
There are no restrictions on foreigners buying investment property in the USA.
The United States is very welcoming to foreign investors and buying property in the USA. British people buying real estate property in the USA has certain advantages such as a stable market, flexible financing options and tax benefits.
There is no citizenship requirement for property sales in the US. Foreigners can also qualify for a mortgage if they meet certain criteria, which mean that non-US citizens can actively seek to invest in property.
Understanding the USA tax rules before you buy property will help you to maximise the return on your investment.
Is the USA property sector a stable market to invest in?
The USA is considered to be one of the most stable markets for property estate investment, with property experts predicting that house prices will increase by 8% in 2021.
What are the key differences foreign investors need to be aware of?
When it comes to buying property for investment in the USA, there are some key factors to be aware of.
As a non-US citizen buying property the IRS Publication 515 sets out basic rules for non-resident aliens.
One of the main pieces of relevant legislation in this area, the Foreign Investment in Real Property Tax Act 1980 (FIRPTA), was enacted by Congress to impose taxation on foreigners when they sell or receive income from a USA-based property interest.
Income generated by USA-based property owned by a foreign investor is taxed at 30% if not connected with a US trade or business concern.
Different USA states have different tax treaties in place, which might provide a reduced tax rate.
When a foreigner sells a US-based property, any capital gain is taxed as if a US citizen or resident had sold the property. This means the gain might qualify for lower capital gains tax treatment, as long as the property has been held for over 12 months by the foreign investor.
Non-resident aliens are subject to a 15% withholding tax on the gross sale proceeds of the property. This is unless the foreigner has specific exemptions, which there are many to mitigate the FIRPTA tax.
To be certain of understanding all the relevant US tax legislation, speak to an expert before investing.
What do I need to know about the Foreign Investment in Real Property Tax Act (FIRPTA)?
The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) was enacted to ensure that foreign sellers of US assets do not get away from paying tax to the IRS.
One of the British real estate property investor’s biggest issue comes when selling a US-based real estate property investment is FIRPTA.
The amount deducted from the proceeds of the sale is 15%. Please note that the FIRPTA 15% tax rate is not based on capital gains rather than net proceeds from the sale. The FIRPTA 15% tax rate is the responsibility of the seller.
However, the buyer has to pay FIRPTA if they do not identify the seller as a foreign person who should pay this tax.
The 15% FIRPTA withholding tax needs to be paid with the completed Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests within 20 days of the sale closure.
It is, therefore, vitally important that the buyer and seller communicate effectively during the sales process.
Can foreign investors avoid FIRPTA tax?
Although a foreign investor is liable to pay FIRPTA, the gain from a sale of an interest in a foreign corporation is not subject to tax under FIRPTA.
A non-resident alien may own US property indirectly through a foreign corporation and sell the shares of that foreign corporation to avoid taxation on the sale’s capital gain.
FIRPTA exemptions are also in place if the sales price is $300,000 or less.
In this instance, the buyer must sign an affidavit stating they intend to use the property for personal purposes for at least 50% of the time the property is occupied during the first two years after purchase.
FIRPTA is not chargeable to British citizens that live in the US and submit a 1040 tax return to the IRS.
What is Withholding Tax and how much does a foreign investor have to pay?
A foreign investor national is subject to withholding tax on US-based income at the standard flat rate of 30%. The tax is generally withheld from the payment made to the foreign national.
A tax treaty is a bilateral agreement between the United States and a foreign government.
The person making the payment is obliged to withhold tax and is called a withholding agent. The person receiving payment from which tax is required to be withheld by the payee.
US law stipulates the persons required to withhold the tax and the persons from whom the tax is withheld. A withholding agent is responsible for withholding tax on payments of US-sourced income.
Speak to a transatlantic tax expert regarding the intricacies of withholding tax before investing in the US.
What are the tax implications for foreign ownership of property in the USA?
A foreign property owner must pay tax on the net rental income on their US tax return which means you can include deductions such as interest deductions for mortgages, advertising costs, and property management costs.
Foreign investors in US real estate have two options when it comes to paying taxes on income received from rental properties.
Firstly, the foreign investor can elect to have a 30% withholding tax taken from each gross rental payment they receive. The withholding agent (usually the property manager) collects the tax and forwards it to the IRS.
If a tax treaty exists between the USA and the investor’s country of residence, the 30% rate may be lower.
Secondly, the foreign investor agrees to prepare a US tax return to report the rental income earned each year. To do so, the investor needs to apply for an Individual Taxpayer Identification Number (ITIN) using Form W-7 and submits it when filing the tax return.
Generally, the buyer/transferee is the withholding agent and is required to withhold 15% of the amount realized on the sale, file the required forms and remit the withholding tax to the IRS.
The 15% FIRPTA tax is not final. It is a withholding tax that the foreign taxpayer credits against their calculated federal tax liability on their FIRPTA real estate gain.
Although foreigners generally are not subject to US income tax on capital gains that are unrelated to the conduct of a business in the United States, the sale of a defined interest in US-based real property (called a USRPI) is treated as income effectively connected with a US trade or business. It is a taxable capital gain to the foreign seller.
When does a foreign property investor need to file a US income tax return?
If you own properties that are rented in the USA, you need to be aware of your tax liabilities.
All rental income must be reported on your tax return, and the associated expenses can be deducted from your rental income.
As a cash basis taxpayer, you generally deduct your rental expenses in the year you pay them.
Can I use a 1031 exchange to avoid FIRPTA and Capital Gains Tax?
The seller may use the proceeds of a US property investment sale to purchase a replacement for real estate property investment.
Please note that the critical word is ‘investment’. The buyer should not use this FIRPTA if:
– The property sold is a home.
– A replacement real estate property is a home.
– The replacement of real estate property is not in the USA.
– Replacement assets is not lower than the gross sales price of the sold real estate property investment.
A 1031 exchange means that the money you obtained from the sale is reinvested. Not only does this mean that FIRPTA may be avoided, but so too is Capital Gains Tax.
How does this affect our UK readers?
To learn more, make sure you head over to our sister company, Optimise Accountants that helps Americans save tax in the UK. It is one thing to be tax-efficient in the UK or the US; it is another thing to be tax-efficient across the Atlantic.
This is why you need to get a tax advisor that truly understands international tax.