09 Mag Buying residential property in New York City (Part IV)
by Maurizio Gardenal partner, Studio legale internazionale Gardenal & Associati Milano, and Anthony Bruozas, Attorney at Law
Articolo pubblicato su “Diritto 24″, rubrica del Sole24Ore.com, 09 maggio 2012
This final part focuses on some key taxation and related fiscal issues which a foreign investor should keep in mind when investing in real estate in the US.
A) What are my taxes?
Real property transactions are taxed on the difference between the owner’s original purchase price and the amount of the sale. The resulting difference is considered either a loss if the owner’s sale is less than the purchase amount, or conversely a profit, or ‘Capital Gain’ if the sale price is greater than the purchase amount. Depending on the state in which the home is located, the total tax on the sales transaction varies. The taxes also vary between US residents and non-residents.
There are other charges which must be taken into consideration when calculating the total costs associated with the purchase and sale of real estate. The closing costs, points paid for the loan (usually required by the mortgage broker as a condition to providing a lower interest rate on the amount of money loaned), and loan application fees would be deducted from the capital gain or loss. The current US (federal capital gain tax rate is 15% for US residents. However, within the state of New York and the city of New York, there is an additional 10% in taxes which must be taken into consideration when contemplating buying and later selling real estate located in New York.
When selling one’s primary residence it is possible for an individual to avoid paying any tax on a Capital Gain. If the home sold was the owner’s primary residence for at least two years out of the past five, the single income tax payer is allowed a profit (gain) of $250,000 before any Capital Gain tax is applied. Married couples are allowed up to $500,000 in profit before they are taxed on their Capital Gain.
There are significant advantages when purchasing real estate for investment purposes, one of the most important being that interest paid on one’s mortgage is deductible. However, the immediate downside is the “points” that one may have paid to the mortgage broker in order to receive a lower interest loan rate. Other fees paid on the closing when the property is subject to a mortgage, such as loan origination fees are also not deductible.
B) What are the Taxes due on sale for a Non-US Resident?
Taxes on the proceeds of sale for non-residents are 30% for foreigners on properties held longer than one year. Double taxation treaties may aso apply on the issue.
The United States created the Foreign Investment in Real Property Tax Act in 1980 which requires withholding taxes directly from the proceeds of the sale in order to guarantee payment of taxes from non-residents. The Internal Revenue Service withholds 10% of the sales price and the state of New York withholds an additional 6.85% in taxes. Either the seller or the buyer upon the sale of real estate must file the IRS form called “Statement of Withholding on Disposition by Foreign Persons of United States Real Property Interests.” Other states require similar filings . To avoid taxes placed upon the sale of real estate, foreign investors can use the protection of an LLC to buy and sell New York City real estate.
When filing personal income taxes with the IRS, the “Schedule D” is used to report Capital Gains. If the individual owned the residence for one year or less, the Capital Gain is reported on the Schedule D as a short-term Capital Gain. If the residence was owned longer than a year, it is reported on the Schedule D as a long-term Capital Gain. The time of ownership is crucial to the period for reinvesting the Capital Gain in the future. If an individual can delay selling the residential home until he has lived in the home for over two years, then he will have longer to reinvest any Capital Gain from the sale of the home.
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 (i.e., 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 experiencing tax losses in the beginning years of their investment, and, therefore, doesn’t owe any taxes to the government, he must file his tax returns on a timely basis to make the election.
A foreign buyer’s overall tax liability may be different than that of a US resident depending upon the buyer’s home country tax treaty with the US, if any. Therefore, it is best to consult a local tax adviser that is familiar with the tax treaty. For instance, the capital gains rate for US residents is 15% (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.
Most troubling for the foreign investor is the following: it is possible to become a resident in the United States for income tax purposes without any deliberate intent to acquire that status. Under the “Substantial Presence Test”, which counts the number of days a person is physically present in the United States, income tax residency would be acquired by an individual who regularly conducts business or otherwise maintains a physical presence in the United States and who does not engage in very deliberate planning to avoid exceeding the limit on days spent in the United States, even if that person’s permanent home is outside the United States.
It should be noted that a foreign person will be considered a U.S. Resident for Tax Purposes if he/she meets the Substantial Presence Test for the calendar year. The test must be applied each calendar year that the individual is in the U.S. To meet the test, a foreign person must:
1. Be physically present in the U.S. for at least 31 days during the current year, and
2. Be physically present 183 days during the 3 year period that included the current year and the 2 years immediately before that, counting:
a. All the days the individual was present in the current year, and
b. 1/3 of the days the individual was present in the 1st year before the current year, and
c. 1/6 of the days the individual was present in the 2nd year before the current year.
Once the foreign real property owner is considered to be US resident, her worldwide income is subject to US income tax.
While most Americans still are wary about real estate and are preoccupied with concerns over the overall economic climate, foreign investors are keeping US real estate brokers busy with their eagerness to buy up New York condo and co-opts. The number of foreign buyers has doubled in the last two years. In just the last 18 months, foreigners have bought one-third of all new condos that were for sale in New York City. Foreign buyers are helping shield Manhattan from the housing slowdown that has continued to plague the rest of the nation and are providing a ready market for thousands of newly built condominiums. Foreigners seem to prefer condos for the amenities and flexible rules that allow renting the unit as investments. That many units are in neighborhoods that are not traditionally residential does not seem to bother the foreign shopper. They deem it beneficial that such neighborhoods are well-known.
Foreign buyers often purchase quickly because they largely view buying an apartment as similar to acquiring a bond or a stock. Buying a condo in Manhattan, however, should not be crammed into a shopping day in the Big Apple. Two factors important to international clients when purchasing property in the U.S. are proximity to their home country and the convenience of air transportation. International buyers were reported in 39 states in 2010, but a slight majority of the total buyers are concentrated in Florida, California, Arizona and Texas. These four states account for 53% of purchases and have remained the top destinations for the past three years, with Florida and California remaining the top two destinations. The median price paid by international buyers in 2010 for a home in the U.S. was $219,400, a decrease from 2009’s median price of $247,100. However, the median price paid by foreign buyers was significantly higher than the overall US median market price, which was $172,500 in 2009. On average, foreign buyers tend to purchase closer to the upper end of the market; 16% of the total international purchases were for homes priced at more than $500,000. Wherever the foreign investor tends to buy, she/he should remember that a US experienced real estate attorney is deemed essential in order to secure the right kind of property while minimizing future risk and to make sure that the deal is ultimately consummated on terms favorable to the foreign investor.