Blogworthy topics from my real estate course today

by Phil Hodgen on December 12, 2008

Today I gave an all-day course on U.S. taxation of nonresident investors in U.S. real estate. (Link is to the next time I’m giving this course — in San Jose on January 6, 2009). The course was sponsored by the Cal CPA Education Foundation. It was at the Sheraton in Anaheim, hard by Disneyland. No, I didn’t go to Disneyland afterwards.

As we went through the day I took notes on a number of topics and questions that seemed blogworthy. I’ll post on them as time goes by. Here they are:

  • Estate tax situs rules for airplanes and boats. (Question: nonresident flies his airplane to the United States and then dies. The nonresident has tangible personal property located in the United States–the airplane that landed in the U.S. Will there be estate tax?)
  • Gift tax rules applicable to the gift of LLC membership interests by nonresidents. (Dad owns U.S. real estate in a single member LLC. Dad is a nonresident of the United States. Dad gives the membership interests in the LLC to his U.S.-resident daughter. Gift tax or not?)
  • Cash gifts by nonresidents. (The eternal problem of “I’m a nonresident and I have a U.S. bank account. What are the gift tax ramifications if I (1) withdraw cash and hand over a stack of $100 bills as a gift to someone? (2) write a check on my U.S. bank account as a gift to someone? (3) other variations on that theme.)
  • The “net election”. I promised to post the magic language you attach to the income tax return to make this election. (This is what you do so rental income is taxed after you deduct related business expenses–net income–rather than having tax on the gross rental income received, without deduction for business expenses).
  • Mortgage situations involving foreign lenders. When interest is paid to the foreign lender there will be 30% withholding tax imposed. What can you do here to reduce/eliminate withholding?
  • Basis step-up on assets held in a foreign grantor trust with a nonresident grantor. How does that work?

Thanks to the 33 people in the room today. If I missed a question, please let me know. You can comment below or shoot me an email. I’ll get to work on these and start writing. Be patient, though. I have a life. :-)

I have cross-posted this to hodgen.com/phil.

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02.04 – Real estate held through partnerships

by Phil Hodgen on December 1, 2008

Partnerships are used all the time for U.S. real estate holding–they are tax-efficient and adaptable to almost every economic deal among co-owners.

Remember that for U.S. estate taxation we are trying to identify exactly “where” something is–inside the United States (thus taxable) or outside the United States (thereby escaping estate taxation).

The view of the U.S. tax authorities is that a partnership interest will be U.S. situs property (subject to the U.S. estate tax on nonresident aliens) when the partnership is engaged in a U.S. trade or business.

The IRS says if death of the partner terminates the partnership, then the decedent’s pro rata share of partnership assets will be U.S. situs assets. If death does not terminate the partnership, then situs is where the partnership does business.

In summary, the taxpayer loses, no matter what:

If the partnership agreement says that the partnership terminates on the death of a partner, then the deceased nonresident is taxed on his or her pro-rata share of the underlying real estate will be subject to U.S. estate tax.

Example.

The nonresident is a 25% partner in a partnership that owns an office building in the United States. The partnership interest says that the partnership will terminate when one of the partners dies.

When the nonresident dies, he or she will be subject to estate tax just as if he or she owned a direct 25% interest in the office building.

If the partnership agreement says that the partnership continues after the death of a partner, then the deceased nonresident’s partnership interest is treated as located in the United States. Thus, it is subject to estate tax.

Example.

The nonresident is a 25% partner in a partnership that owns an office building in the United States. The partnership interest says that the partnership will continue in existence when one of the partners dies.

When the nonresident dies, he or she is treated as owning a asset–partnership interest located in the United States–that is subject to U.S. estate tax. The value of that partnership interest is calculated, and the nonresident’s heirs must pay estate on that partnership interest.

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02.03 – Assets subject to estate tax: direct ownership, ownership through corporations

by Phil Hodgen on December 1, 2008

We’re assuming for the rest of this discussion that you’re a nonresident for estate tax purposes. This means that the estate tax will only be imposed on your “U.S. situs” assets–properly located in the United States

Direct ownership

Nothing says “U.S. situs asset” quite so much as direct ownership in U.S. real estate. If an individual dies while holding title to U.S. real estate, there will be U.S. estate taxation of that asset.

For U.S. law, real estate includes the land and all buildings and “fixtures.” If it is permanently attached to the land, it is real estate. A building is real estate. A sidewalk is real estate.

Stock of corporations

Look to the place of incorporation.

Stock of a corporation formed in the United States is situated in the United States. Stock of a corporation formed outside the United States is not situated in the United States.

Place of management, source of income, physical location of the stock certificate, etc. do not matter.

U.S. real estate inside foreign corporation

Stock of a foreign corporation is not a U.S. situs asset. Nonresident alien owns stock of a foreign corporation? Guess what—it does not matter what the foreign corporation owns.

Let’s say the nonresident alien owns the stock of a foreign corporation, which in turn owns U.S. real estate (clearly a U.S. situs asset). The nonresident falls over dead, owning a non-U.S. situs asset—stock of a foreign corporation. This passes to his heirs, free of estate tax.

California corporation owns real estate

Stock of a corporation formed under U.S. law is considered located inside the United States, making the stockholder vulnerable to estate tax when he or she dies.

A nonresident owns all of the stock of a California corporation. The California corporation owns U.S. real estate. The nonresident dies.
The decedent’s estate does not include ownership of real estate. His estate owns stock of a California corporation. The stock is a U.S. situs asset so the heirs will be estate tax on the fair market value of the stock.

Note the important distinction–the estate tax is not imposed on the real estate itself, but on the stock of the U.S. corporation (in this case I assumed California, but any other State will do).

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