Generally, a foreign investor may purchase a direct interest in commercial real estate, although it is advisable that, for liability protection purposes, an interest in commercial real estate be held through a legal entity. Moreover, lenders may require that a foreign investor hold its interest through a legal entity. In certain circumstances a federal statutory requirement to file a national security clearance process overseen by the US federal government body known as the Committee on Foreign Investment in the United States (CFIUS) may be required. Furthermore, foreign investment in a US business which results in a foreign person or entity owning 10% or more of the voting securities or equivalent interests in a US business enterprise may be subject to reporting requirements administered by the Bureau of Economic Analysis (BEA) of the US Department of Commerce.
Last modified 22 Mar 2024
A foreign investor may purchase a direct interest in a real estate asset, or the foreign investor may establish a legal entity which will hold title to the real estate asset. The concept of a permanent establishment involves the setting up of a legal entity discussed elsewhere in this section.
Last modified 22 Mar 2024
The most common vehicles used to hold real estate in the US are limited liability companies and limited partnerships. Both entities offer liability protection and both are pass-through entities for US federal income tax purposes, which means that the entity itself does not pay income tax; instead, the partners or members are taxed on their share of the profits. A general partnership is also a pass-through entity for US federal income tax purposes, but does not provide liability protection; thus, a general partnership might be utilized when all partners are themselves liability protection entities (such as limited liability companies).
The United States also recognizes corporations which may be ‘C corporations’ or ‘S corporations’ for US federal income tax purposes. ‘C corporations’ are not pass-through entities and thus are rarely used to hold real estate. ‘S corporations’ are pass-through entities, but ‘S corporations’ are not permitted to have entities or non-resident aliens as shareholders. For these reasons and because ‘S corporations’ have tax disadvantages that make them undesirable for holding real estate, those types of entities are not dealt with here.
Other vehicles used to hold real estate include land trusts (uncommon and typically used as an estate planning tool for wealth transfers; including minimizing taxes and the proper and efficient transfer of assets).
Finally, real estate may also be held by entities such as real estate investment trusts (REITs) or publicly traded partnerships. The governance and tax treatment of such entities are very complex.
The cost of setting up a legal entity can vary and depends on several factors. First, costs will depend on which of the 50 states is selected as the state of formation; each state has its own schedule of formation fees, annual fees and taxes. It is common in the US to form legal entities in Delaware (Delaware laws are often preferred); however, if the real estate is located in another state (usually the case), the Delaware entity will need to register (and pay applicable fees and taxes) in the state where the real estate is located.
Second, cost will depend on the terms of the governing documents for the legal entity; if there is only one investor, the governing documents are usually simple, but if there are multiple investors with varying interests, the governing documents can be complex, which will increase legal fees and costs. Finally, the state tax treatment of certain legal entities (such as limited liability companies) varies from state to state so that tax advice is often needed with regard to the choice of the appropriate legal entity.
The laws which govern a legal entity will be the laws of the state in which the legal entity is formed. Each state typically has a set of governing statutes for each of corporations, general partnerships, limited partnerships, and limited liability companies. Some states also permit real estate to be held through a land trust.
Note that a real estate investment trust or REIT is a US federal income tax designation for a corporation, trust or association which invests in real estate and functions to reduce or eliminate corporate income taxes. REITs are required to distribute 90 percent of their income, which may be taxable, into the hands of the investors, and have many other complex requirements. The REIT structure was designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks. Like other corporations, REITs can be publicly or privately held. Public REITs may be listed on public stock exchanges like shares of common stock in other vehicles.
On 1 January 2024, the Corporate Transparency Act (CTA) came into effect, requiring certain non-exempt business entities (known as “reporting companies”) to file information on their “beneficial owners” with the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN). The CTA also requires filing information about “company applicants” for entities formed on or after 1 January 2024, which may include executives, law firm personnel, and corporate filing and maintenance company employees. The CTA requires any “reporting company” to complete and submit disclosure forms to FinCEN, including the identity of any “beneficial owner” of the company. A “reporting company” is a corporation, limited liability company or other entity created by filing a document with a secretary of state or similar office under the laws of a state in the United States. This includes foreign companies registered to do business in the United States. FinCEN has established 23 types of exemptions from being a reporting company. These include governmental authorities, certain types of banks and bank holding companies, broker dealers, investment advisors and other investment companies registered with the SEC, insurance companies, large corporations and certain “pooled investment vehicles”. Determining whether an entity qualifies for an exemption will require a close reading of the text of each exemption and related definitions. Reporting companies created before 1 January 2024 must file by 1 January 2024. Reporting companies formed on or after 1 January 2024 must file within 90 days of formation. Reporting companies that lose an exemption must file within 30 days of losing the exemption. Individual states, including New York, have enacted or may enact similar legislation requiring disclosures regarding beneficial owners of business entities.
Last modified 22 Mar 2024
A US limited partnership is a partnership in which there are one or more limited partners and one or more general partners. The limited partners generally do not participate in the management of the partnership or its assets, and a limited partner is liable for the debts and obligations of the limited partnership only to the extent of its capital contributions (ie its investment). The general partner manages the limited partnership and its assets and is liable for the obligations of the limited partnership. Thus, the general partner is usually an entity that provides liability protection (such as a corporation or a limited liability company). Operations of a limited partnership are typically funded through the capital contributions of the partners and debt from third-party lenders. Many states have creditor protection laws which, in certain circumstances, allow for the recapture of distributions made within a certain period if the limited partnership is unable to pay its debts.
A limited liability company (often referred to as an LLC) is an entity owned by persons or entities called members, all of whom have limited liability. The governance of the LLC and the economic interest of the members are described in a limited liability company agreement, also often called an operating agreement. An LLC can be managed by its members (similar to the way a general partnership is managed) or it can be managed by a manager or board of managers. It is common to have a manager when there are more than just a few members. Unlike partnerships, an LLC can exist with only one member. A member of an LLC is liable for the debts and obligations of the LLC only to the extent of its capital contributions (ie its investment). An LLC will be governed by the laws of the state in which it is formed. Many states have creditor protection laws which, under certain circumstances, allow for the recapture of distributions made within a certain period if the LLC is unable to pay its debts.
A US general partnership is a partnership in which there are two or more general partners. Partners in a general partnership have no liability protection; each partner is jointly and severally liable for the debts and obligations of the general partnership. Liability protection can be obtained by investing in the general partnership through a liability protection entity such as an LLC. Operations of a general partnership are typically funded through the capital contributions of the partners and debt from third-party lenders.
Depending on the state of formation, some type of certificate may need to be filed in connection with the formation of a general partnership. A general partnership may be governed by a partnership agreement among the partners. The partners in a general partnership may submit all actions to partner vote or the partners may elect a managing partner who is given certain powers to act on behalf of the partnership.
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While there are generally no legal minimum capital requirements imposed by law, lenders and other third parties contracting with the partnership or LLC may impose certain minimum capital requirements.
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In connection with the formation of a limited partnership or LLC, filing fees typically range from US$50 to US$500, depending on the state of formation; the limited partnership or LLC will also need to pay fees to any other state where it registers to do business (because it holds real estate in that state). Legal fees for the agreement of limited partnership or operating agreement depend on the complexity of the agreement and the amount of negotiation among the parties; fees can range from US$2,500 to US$50,000 or more.
Some states require a filing in connection with the formation of a general partnership. Filing fees typically range from US$50 to US$500, depending on the state of formation; the general partnership may also need to pay fees to any other state where it registers to do business (because it holds real estate in that state). Legal fees for the agreement of general partnership depend on the complexity of the agreement and the amount of negotiation among the parties; fees can range from US$2,500 to US$50,000 or more.
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A limited partnership or LLC is operative as soon as its certificate of limited partnership/certificate of formation is filed with the secretary of state of the state in which the limited partnership or LLC is formed. As a practical matter, because of the requirements of lenders and others with whom the limited partnership or LLC may do business, the limited partnership or LLC will not be able to effectively operate until it has a signed partnership agreement/operating agreement and received capital contributions from its partners/members.
A general partnership is formed by the association of two or more persons or entities to carry on as co-owners a business for profit. Thus, under certain circumstances, two parties may be deemed to be in a partnership even though that was not their intention. A general partnership comes into existence as soon as two or more persons or entities sign an agreement creating the partnership.
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A limited partnership must have at least one general partner who manages the partnership and its assets. While certain key decisions can be submitted to the vote of the limited partners, the limited partners generally do not participate in day-to-day decisions affecting the partnership. If a limited partner were to participate in the management of a limited partnership, its liability protection could be lost.
Generally, the operating agreement will describe how the LLC is managed, either by the vote of the members or the managers. If the LLC is managed by one or more managers, there are often certain major decisions that are put to the vote of the members. Unlike corporations, there are not generally any formalities (such as corporate minutes) applicable to LLCs.
A general partnership is managed by the vote of its partners. The partners may designate a managing partner to oversee the day-to-day business of the partnership, and delegate certain powers and duties to the managing partner.
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Accounting costs will depend on the number of holdings of the limited partnership or LLC, the complexity of the economics of the partnership or LLC, and whether audited financial statements will be required for the partnership or LLC.
Last modified 22 Mar 2024
For US federal income tax purposes, a limited partnership is a pass-through entity. Thus, the limited partnership itself does not pay any US federal income tax. Instead, the income and loss of the limited partnership is passed to the partners who each report their share of income and loss on their tax returns. The taxable income passed to the partners retains its character; thus, if the partnership sells an appreciated capital asset that it has held for 12 months, each partner will be allocated capital gain (currently taxed in the US at more advantageous capital gains rates) from that sale. If the partnership has rental income, each partner will be allocated ordinary income. Note that some states charge a separate flat tax on limited partnerships owning real estate in their state.
For US federal income tax purposes, an LLC is a pass-through entity. Thus, the LLC itself does not pay any US federal income tax. Instead, the income and loss of the LLC is passed to the members who each report their share of income and loss on their tax returns. The taxable income passed to the members retains its character; thus, if the LLC sells an appreciated capital asset that it has held for 12 months, each member will be allocated capital gain (currently taxed in the US at more advantageous capital gains rates) from that sale. If the LLC has rental income, each member will be allocated ordinary income. Some states (such as California) impose an entity-level tax on LLCs.
For US federal income tax purposes, a general partnership is a pass-through entity. Thus, the general partnership itself does not pay any US federal income tax. Instead, the income and loss of the general partnership is passed to the partners who each report their share of income and loss on their tax returns. The taxable income passed to the partners retains its character; thus, if the partnership sells an appreciated capital asset that it has held for 12 months, each partner will be allocated capital gain (currently taxed in the US at more advantageous capital gains rates) from that sale. If the partnership has rental income, each partner will be allocated ordinary income.
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How much does corporate and accounting compliance cost for each type of corporate vehicle used to invest in real estate?
Accounting costs will depend on the number of holdings of the limited partnership or LLC, the complexity of the economics of the partnership or LLC, and whether audited financial statements will be required for the partnership or LLC.
Last modified 22 Mar 2024