Tax Structuring Strategies For Foreign Investment in US Real Estate
Many US citizens, who reside outside the United States, are subject to taxation on their worldwide investments. For instance, in many countries, the owner of a company that has been established abroad must pay taxation on all income derived from that organization. In such situations, he can decide to relinquish his US citizenship and use it as an asset protection plan. Such cases are quite common and have led to the formation of what is known as a tax deferral system. A US citizen who effectively uses tax deferral to protect his assets from overseas taxation can claim tax relief by claiming an equivalent quantity of tax relief overseas.
What is meant by tax deferral? A tax deferral is a reduction of the amount of tax liability incurred on an asset or account because of lack of knowledge on tax legislation or a lack of comprehension of the tax law . It essentially means that a US citizen who effectively uses tax deferral to minimize his tax liability may claim tax relief overseas in the form of a reduced tax liability. There are different types of tax deferral and there are different ways of claiming tax relief on them.
One type of deferral is by way of a lease. Under such a lease, a component of the expense of the property is kept by the lessee and used as collateral for the same. In return, the lessee is required to make monthly payments to the owner and shouldn’t encroach upon the land. Such a lease generally leads to tax liability minimization. Leasing for business purposes is typically a better option for people who wish to enjoy tax benefits without necessarily jeopardizing the safety of their investment.
The second type of deferral is through ownership or investment in overseas property. In this case, the foreign owner gains a”dominant interest” in the property which he can use for investment purposes only. Tax advantage on this kind of investment is greater than on the first one since the overseas property could be developed in any way desired by the operator. However, the disadvantages here are fairly obvious: the foreign owner risks exposure to foreign currency risks (devaluation and admiration ); second, there’s the possibility of not being able to exercise management control over development projects which may require financing; third, the location of the property might be affected by local ordinances that may ban development altogether.
An important yet often overlooked approach to tax avoidance through property is through rental income. Here, the owner rents out his property to tenants, who pay taxes on their rental income according to the law. This is considered a kind of tax avoidance as it doesn’t raise the tax liability of the tenant. However, a property owner should make sure that the tenants have the ability to legally obtain tax liability relief also. Otherwise, this arrangement might not serve its purpose.
Real estate investments in the Caribbean are ideal for tax liability reduction since there aren’t any inheritance taxes or stamp duties. In this case, the first time income tax is paid is only on the first year of residence or, if a higher annual return is decided upon, on the amount of increase in annual income. It’s important to note, though, that despite this tax liability reduction, the total tax amount because the US authorities is still greater than the value of the home offered. The property must, therefore, be sold at a higher cost to realize the full tax liability reduction.
A similar strategy for tax liability reduction may be applied to foreign investment in the form of a lease purchase agreement. Like the rental revenue plan, the lessee pays taxes on his rental income according to the law but does not have to pay taxes on his capital gain from the sale of the property. Typically, the rental purchase arrangement enables the lessee to deduct the expenses paid to acquire the property, such as commissions and mortgage insurance.
Finally, there’s also the strategy of tax sheltering. This refers to using a foreign country’s tax laws to defer paying US tax on certain types of overseas transactions. Generally, this is used by business owners who are domiciled in low tax countries. There are several advantages to using tax sheltering strategies. They include avoidance of double taxation and avoidance of penalties and surcharges which would normally be paid when tax payments are made.