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Tax Implications of US Real Estate Ownership by Foreign Nationals

There are many rules and regulations that foreign nationals must comply with when owning real property in the US. Prior to the pandemic, US real estate ownership by foreign nationals was on the rise.

Here are the most common questions that foreign nationals ask when considering investing in US real estate:

  • What is passive ownership and what is the current tax rate on rental income generated by US real estate? Real estate is considered passive income by nature, unless a taxpayer qualifies as a real estate professional by meeting some stringent rules with respect to operations of the real estate owned. Typically, that passive income is subject to tax at a flat 30% on the gross rental income unless the net election was made and the property meets the requirements to be a US trade or business.
  • What is the net election and how does it affect taxes? The net election means that foreign nationals can elect for their rental income to be taxed after all eligible expenses are considered. The net taxable income is normally subject to tax on graduated tax rates.
  • What happens once the net election is made? The net election is only required to be made once, typically on the first US tax return filed. It continues until it is revoked.
  • What are some deductible expenses that can be deducted from rental income as a foreign national? Some of the typically deductible expenses are depreciation, mortgage interest, property maintenance, and property taxes. Some tax rules are very similar to those for US residents, but some are not, and must be carefully understood.
  • What gets reported as capital gains or losses when real estate is sold? Property gains or losses are reported similarly to those of a US resident. For example, when a foreign national sells real estate for a gain, both the appreciation of the property and any recapture of depreciation taken is subject to tax. The depreciation recaptured is taxed at 25%. The remaining capital gains are taxed at the rates of 15% or 20% depending on the income levels of the foreign national.
  • What is the Foreign Investment in Real Property Tax Act (FIRPTA)? FIRPTA is an act that requires a withholding tax of 15% of the sale proceeds when a foreign national sells US real estate or sells an entity which is considered to be a “USRPI” (U.S. Real Property Investment). In a simple transaction, the withholding agent is typically the real estate buyer, who must determine if the seller is foreign and subject to FIRPTA. This withholding requirement must always be met.
  • What are the tax return filing requirements for a foreign national? When a foreign national has rental income derived from rental real estate and has made the net election, that foreign national is subject to income tax and must file a US tax return (Form 1040-NR). A nonresident who fails to file a tax return loses the ability to claim deductions against any rental income, therefore causing the gross rents to be subject to the flat 30% tax rate.

Overall, it’s imperative for foreign nationals to understand the tax implications when receiving rental income from real estate investments and the transactional tax issues that are incurred when selling US real estate.

Author: George Samios, CPA, Real Estate Services Team Member | gsamios@withum.com

For more information or any questions, please contact a member of the Real Estate Services Team.

Real Estate Services

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