Taxes across borders: a guide to foreign investment in California real estate.

• Author: Stein, Jacob
• Position: Taxationguidance

While a non-resident alien (NRA) desiring to invest in U.S. real estate property typically has mans goals, such as liability protection and privacy, the main concern is to minimize worldwide income and estate tax liability.

Privacy and Liability

Privacy is attainable by acquiring real estate through a trust or a legal entity--preferably an LLC. A. generic name should be used and, for a trust, a third-party trustee.

Corporations, limited partnerships and tics will afford their individual owners a shield for any liability arising from the assets or the business of the entity. However, limited partnerships and LLCs are not required to maintain certain corporate formalities like holding annual meetings of shareholders and maintaining annual minutes, affording creditors fewer bases for piercing the corporate veil. Interests in limited partnerships and LLCs are not attachable by creditors, making them a more effective asset protection vehicle than corporations.

Income Taxation of Real Estate

For federal income tax purposes, an NRA is defined as either a foreign corporation or person who is:

1. Physically present in the U.S. for less than 183 days in any given year:

2. Physically present in the U.S. for less than 31 days in the current year;

3. Physically present for less than 183 total days for a three-year period (using a weighing formula); and

4. Does not hold a green card.

   Income tax rules applicable to NRAs can be quite complex. Generally, an NRA pays a flat 30 percent tax on U.S.-source "fixed or determinable, annual or periodical" (FDAP) income that is not effectively connected to a U.S. trade or business, and which is subject to tax withholding by the payor. FDAP includes interest, dividends, royalties and rents, insurance premiums, annuity payments, gambling winnings and alimony. An applicable treaty may reduce the rate of tax. The income is taxed on a gross basis, with almost no offsetting deductions.

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   NRAs, however, are generally not taxable on their capital gains from U.S. sources.

   An NRA is taxed on income effectively connected to a U.S. trade or business under the same rules as all U.S. taxpayers. U.S. trade or business has been held to include providing personal services in the United States; selling products in the United States directly or through an agent; soliciting orders from the United States and then exporting merchandise outside the United States; and manufacturing, maintaining a retail store, and maintaining corporate offices, in the United States.

   NRAs will be engaged in a U.S. trade or business if they are a general or limited partner in a U.S. partnership engaged in a trade or business...