An individual/organization/company may invest in US real estate either directly or indirectly through any one of many different legal entities, including corporations, general and limited partnerships, limited liability companies, real estate investment trusts (REITs) and other types of trusts.
Last modified 22 Mar 2024
No US federal taxes are imposed on the purchase of real estate. Various states and localities impose taxes on the transfer of interests in real property within that state and/or local jurisdictions, which can be payable when deeds (documents) or other instruments which convey interests in real property are officially recorded (also known as ‘documentary stamp taxes’, ‘documentary transfer taxes’, or ‘real estate transfer taxes’). In some states (including some local jurisdictions within such state), documentary transfer tax or real estate transfer tax is due on transfers of certain interests in legal entities that own real property within the respective state.
Also, various states impose taxes when mortgages or deeds of trust securing loans that are secured by interests in real estate are officially recorded.
Last modified 22 Mar 2024
Currently, there are no value added taxes imposed under the US federal tax system or the tax systems of any of the states.
Last modified 22 Mar 2024
Many states and localities impose costs and fees (in addition to taxes) for recording and filing deeds, mortgages, and other documents in the land records.
Other costs typically include the cost of obtaining title insurance, escrow fees, and fees for professional advisors.
Last modified 22 Mar 2024
The tax system in the US is a complex web of various taxes imposed by different governmental authorities. The multi-layered tax system reflects the US constitutional structure of overlapping federal and state governments, with the result that taxes may be imposed at any one or more of the following levels:
While US federal taxes apply uniformly throughout the country, state and local taxes vary widely from jurisdiction to jurisdiction.
Taxable net income (ie the excess of income over deductions) derived from the ownership and operation of real property is treated as ordinary income and is subject to federal income tax at graduated rates. Effective January 2018, the maximum income tax rate on ordinary income has been reduced to 21 percent for corporations and 37 percent for individuals (note, however, the maximum income tax rate on ordinary income for individuals is set to sunset after 2025 and return to 39.6 percent). In addition, individual taxpayers holding interests in ‘pass-through entities’ such as partnerships and limited liability companies may be entitled to a deduction of up to 20 percent of ‘qualified business income’, subject to certain restrictions, income limitations, and exclusions. As of 2013, US individuals, estates and trusts are potentially subject to an additional tax known as the Net Investment Income Tax (NIIT), which applies at a rate of 3.8 percent on the lesser of net investment income (including, amongst other items, gain from the sale of investment real estate) or the amount by which modified adjusted gross income exceeds a statutory threshold (ranging from US$125,000 – US$250,000 depending on filing status); non-resident aliens, however, are not subject to the NIIT.
Generally, a limited liability company or other unincorporated business entity that has a single owner is disregarded for US tax purposes. The tax consequences of owning real property indirectly through a disregarded entity are substantially the same as if the property were held directly by the single owner of the disregarded entity.
Real property that is owned by an entity that is classified as a partnership for US tax purposes generally is not subject to US federal income tax. Instead, the taxable income from the ownership and operation of the property ‘flows through’ the partnership to the partners, who are subject to tax on the share of that income which is distributed to them.
If real property is owned by an entity that is classified as a corporation for US tax purposes, net income from the ownership and operation of the property is subject to two levels of federal income tax. First, the corporation is subject to tax on any net income at regular tax rates applicable to US corporations. In addition, dividends paid by the corporation to its shareholders are subject to tax at the shareholder level.
US tax law provides a tax-efficient treatment for a corporation (or trust) that qualifies for and elects to be taxed as a real estate investment trust (REIT). To qualify as a REIT, a corporation (or trust) must principally own interests in real estate and satisfy other highly technical organizational, income and ownership requirements. The governance and tax treatment of such entity is very complex. A REIT, assuming that it complies with various REIT requirements, will not be subject to US federal income tax.
Most (but not all) states impose income tax on the net income generated from the ownership and operation of real property owned, and business activities conducted within, that state. Income taxes may also be imposed at the local (city and/or county) level.
Most states and/or localities (cities and counties) impose some form of ad valorem property tax on the ownership of real property. These taxes typically are computed as a percentage of the assessed fair market value of the property, and generally are not subject to offset or reduction.
The states and localities impose a variety of other taxes that may be relevant to the ownership and operation of real property, including sales and use taxes, transfer taxes and taxes on the logging of official records, franchise taxes and gross receipts taxes.
Last modified 22 Mar 2024
Typically, a business entity (such as a corporation, limited partnership or limited liability company) is required to pay fees and charges to the state where it is formed and each state in which it is registered to do business.
Last modified 22 Mar 2024
Taxable net income (ie the excess of income over deductions) derived from the ownership and operation of real property is treated as ordinary income and is subject to federal income tax at graduated rates. Under current law, the maximum income tax rate on ordinary income is 35 percent for corporations and 39.6 percent for individuals. As of 2013, US individuals, estates and trusts are potentially subject to an additional tax known as the Net Investment Income Tax (NIIT), which applies at a rate of 3.8 percent on the lesser of net investment income (including, amongst other items, gain from the sale of investment real estate) or the amount by which modified adjusted gross income exceeds a statutory threshold (ranging from US$125,000 – US$250,000 depending on filing status); non-resident aliens, however, are not subject to the NIIT.
Last modified 22 Mar 2024
The tax system in the US is a complex web of various taxes imposed by different governing authorities. The multi-layered tax system reflects the US constitutional structure of overlapping federal and state governments, with the result that taxes may be imposed at any one or more of the following levels:
While US federal taxes apply uniformly throughout the country, state and local taxes vary widely from jurisdiction to jurisdiction.
Taxable net income (ie the excess of income over deductions) derived from the ownership and operation of real property is treated as ordinary income and is subject to federal income tax at graduated rates. Effective January 2018, the maximum income tax rate on ordinary income has been reduced to 21 percent for corporations and 37 percent for individuals (note, however, the maximum income tax rate on ordinary income for individuals is set to sunset after 2025 and return to 39.6 percent). In addition, individual taxpayers holding interests in ‘pass-through entities’ such as partnerships and limited liability companies may be entitled to a deduction of up to 20 percent of ‘qualified business income’, subject to certain restrictions, income limitations, and exclusions. As of 2013, US individuals, estates and trusts are potentially subject to an additional tax known as the Net Investment Income Tax (NIIT), which applies at a rate of 3.8 percent on the lesser of net investment income (including, amongst other items, gain from the sale of investment real estate) or the amount by which modified adjusted gross income exceeds a statutory threshold (ranging from US$125,000 – US$250,000 depending on filing status); non-resident aliens, however, are not subject to the NIIT.
Generally, a limited liability company or other unincorporated business entity that has a single owner is disregarded for US tax purposes. The tax consequences of owning real property indirectly through a disregarded entity are substantially the same as if the property were held directly by the single owner of the disregarded entity.
Real property that is owned by an entity that is classified as a partnership for US tax purposes generally is not subject to US federal income tax. Instead, the taxable income from the ownership and operation of the property ‘flows through’ the partnership to the partners, who are subject to tax on the share of that income which is distributed to them.
If real property is owned by an entity that is classified as a corporation for US tax purposes, net income from the ownership and operation of the property is subject to two levels of federal income tax. First, the corporation is subject to tax on any net income at regular tax rates applicable to US corporations. In addition, dividends paid by the corporation to its shareholders are subject to tax at the shareholder level.
US tax law provides a tax-efficient treatment for a corporation (or trust) that qualifies for and elects to be taxed as a real estate investment trust (REIT). To qualify as a REIT, a corporation (or trust) must principally own interests in real estate and satisfy other highly technical organizational, income and ownership requirements. The governance and tax treatment of such entity is very complex. A REIT, assuming that it complies with various REIT requirements, will not be subject to US federal income tax.
In computing taxable income from the ownership and operation of real estate, the owner generally is entitled to deduct interest expense on borrowings to acquire, own and operate the property, which may be capped at 30% of ‘adjusted taxable income’ of the applicable year, as well as the ordinary and necessary costs of owning and operating the property. An owner of buildings and other improvements to US real estate is also generally entitled to reduce taxable income by deductions for depreciation or cost recovery deductions.
No depreciation deductions may be claimed with respect to the cost of land. Under current law, the cost of building improvements is generally depreciated on a straight-line basis over 27.5 years for residential rental property, and 39 years for other types of non-residential real property. Electing to extend the depreciation recovery period may result in a more beneficial interest expense deduction if the 30% cap applies.
Generally, corporate taxpayers can use taxable losses generated from the ownership and operation of the corporation’s other properties and other business activities to offset current and future taxable net income derived from the ownership and operation of real property owned by the corporation up to 80 percent of such taxable income in a given year. The ability of an individual taxpayer to use taxable losses generated from the ownership and operation of other properties and other business activities to offset taxable net income derived from the ownership and operation of real property owned by the individual is much more restricted, in light of various complex limitations imposed by federal income tax laws.
Most (but not all) states impose income tax on the net income generated from the ownership and operation of real property owned and business activities conducted within that state. Income taxes may also be imposed at the local (city and county) level.
Last modified 22 Mar 2024
Generally, a limited liability company or other unincorporated business entity that has a single owner is disregarded for US tax purposes. Accordingly, there should be no federal tax consequences to a single owner of a disregarded entity from cash distributions made to him or it by the disregarded entity.
Taxable income from the ownership and operation of real property owned by an entity that is classified as a partnership for US tax purposes ‘flows through’ the partnership to the partners, who are subject to tax on their shares of that income, regardless of the amount of cash distributions actually made by the partnership to its partners. Any cash distributions to a partner that exceed the partner’s adjusted tax basis in his or its partnership interest usually generates capital gain as if the partner had sold a portion of his or its partnership interest.
Dividends paid by a corporation to its shareholders are subject to tax at the shareholder level at rates currently below that applicable to ordinary income. Dividends paid by a US corporation to a shareholder that is itself a corporation subject to tax in the US will generally be eligible for a dividends-received deduction (ranging from 50 percent to 100 percent, depending on the percentage of stock ownership held by the distributee stockholder). In addition to regular corporate income tax, a foreign corporation that has a branch holding US real property in a US trade or business will potentially be subject to two branch level taxes.
Distributions made by a REIT to its shareholders will generally be taken into account as ordinary dividend income, but may also constitute capital gains or return of capital.
Where a foreign person invests in an entity taxed as a partnership, a federal withholding tax of 21% for corporate foreign partners and 37% for non-corporate foreign partners generally is imposed on the foreign partner’s distributive share of taxable income of the partnership that is ‘effectively connected’ with a US trade or business (whether or not such income is distributed). In addition, to the extent a foreign person realizes any fixed, determinable, annual or periodical income (such as interest and dividend income) from a business entity that is not effectively connected with a US trade or business, such income generally is subject to a 30% federal withholding tax.
Withholding taxes may be reduced or eliminated with respect to certain types of income under applicable income tax treaties. Amounts paid as US withholding taxes may be claimed by the foreign person as a credit against its US federal income tax liabilities with respect to the same categories of income.
Most (but not all) states impose income tax on the net income generated from the ownership and operation of real property owned and business activities conducted within that state. Income taxes may also be imposed at the local (city and county) level.
Last modified 22 Mar 2024
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Last modified 22 Mar 2024
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Last modified 22 Mar 2024
Gains from the disposition of real property that has been held by a non-corporate taxpayer for more than one year generally enjoy a reduced federal capital gains tax rate of 20 percent. However, if the real property includes building improvements that have been previously depreciated, gains up to the aggregate amount of prior depreciation deductions are taxed at a special federal rate of 25 percent. Real property that is held for less than a year or is held in the ordinary course of a trade or business is taxed at regular tax rates. Corporations do not enjoy the benefit of reduced capital gains tax rates applicable to individual taxpayers.
Generally, a limited liability company or other unincorporated business entity that has a single owner is disregarded for US tax purposes. Accordingly, any taxable gains from the sale or other disposition of real property is subject to tax by the single owner as if the single owner had directly owned the property.
Taxable gains from the sale or disposition of real property owned by an entity that is classified as a partnership for US tax purposes ‘flows through’ the partnership to the partners, who are subject to tax on their shares of that gain, regardless of the amount of cash distributions actually made by the partnership to its partners. The character of the gain (as ordinary income or capital gain) passes through the partnership to its partners.
Any cash distributions to a partner that exceed the partner’s adjusted tax basis in his or its partnership interest usually generates capital gain as if the partner had sold a portion of his or its partnership interest.
Gain from the sale or disposition of real property by a regular corporation is subject to two levels of income tax. First, the corporation is subject to tax on gain from the sale or disposition of the property at regular tax rates applicable to US corporations. In addition, dividends paid by the corporation to its shareholders are subject to tax at the shareholder level (see also Income tax withholding for foreign investors, above). If a corporation sells all of its US real property and then liquidates, the corporation is subject to income tax on gains from the sale of the property, but foreign stockholders will not be subject to tax on liquidating distributions from the corporation.
A REIT, assuming that it complies with various REIT requirements, will not be subject to US federal income tax on gains realized from the sale or disposition of real property. A REIT may designate distributions to its shareholders as capital gain dividends, to the extent that they do not exceed the actual net capital gain of the REIT for the taxable year, in which case the distributions are taxable in the hands of stockholders as long-term capital gains.
A significant tax benefit to the ownership of US real estate is the ability of the owner to defer current income tax upon the disposition of real property through a like-kind exchange transaction. Gains realized from a like-kind exchange of US real property will not be recognized currently but will be deferred if the owner acquires real property of a like kind and of equal value, and otherwise complies with complex timing, payment arrangements and other requirements applicable to exchange transactions.
The Foreign Investment in Real Property Tax Act (FIRPTA) provides special rules for gains from the disposition of a ‘US real property interest’ (USRPI). Gains realized by a foreign investor from the sale of a USRPI are treated as effectively connected with a US trade or business carried on by the foreign investor.
The liability of foreign investors for FIRPTA tax is enforced by a comprehensive withholding tax regime that applies to a disposition of a USRPI by any foreign person, under which the purchaser of a USRPI is required to withhold 15% of the gross sales price and pay that amount over to the Internal Revenue Service. Distributions from a REIT that are sourced from the disposition of a USRPI are subject to FIRPTA tax and the REIT is required to withhold 21% of such distributions and pay that amount over to the Internal Revenue Service. The amount withheld and paid over is not an additional tax, but is treated as a tax payment against the foreign investor’s actual US income tax liability. No FIRPTA tax is imposed on a sale of REIT shares if:
Certain “qualified foreign pension funds” (generally, certain non-US retirement and pension funds satisfying certain conditions), and entities all the interests of which are held by qualified foreign pension funds, that dispose of (or that receive REIT distributions that are sourced from the disposition of) interests in USRPIs are exempt from FIRPTA tax. Significantly, the exemption does not apply to tax on operating income and/or ordinary dividends from REITs, and therefore significant tax planning is still required for such investors.
Most (but not all) states impose income tax on gains from the sale or other disposition of real property located within that state. Income taxes may also be imposed at the local (city and county) level. Various cities, counties and other local jurisdictions also require withholding against taxable gains from the sale or disposition of property in that local jurisdiction.
Various states and localities impose taxes on the transfer of interests in real property within that state and upon the recordation of deeds (also known as ‘documentary stamp taxes’) conveying interests in real property.
Last modified 22 Mar 2024
None.
Last modified 22 Mar 2024
How can investment in real estate by an individual/organization/company be set up?
An individual/organization/company may invest in US real estate either directly or indirectly through any one of many different legal entities, including corporations, general and limited partnerships, limited liability companies, real estate investment trusts (REITs) and other types of trusts.
Last modified 22 Mar 2024