(Partner article) In times of crisis, the value of real estate tends to fall: this can be the perfect opportunity to acquire a coveted property.
Florida has long been a state conducive to real estate investment, especially for foreigners and expatriates. That’s why market players use modern methods to sell and buy at a distance. Buyers can, for example, visit properties virtually, and deeds of sale can be digitally authenticated on embellished platforms.
If you want to take advantage of the current context to make a real estate investment in Florida, we invite you to ask yourself the crucial question of the legal structure to use to make your investment before "pressing the button". Alexandre Ballerini, French-speaking lawyer in real estate, companies and international taxation based in Florida, and Jean-Philippe Saurat, partner of the accounting firm Massat Consulting Group, offer us a full explanation of the different options, supporting examples.
What are the legal structures to remember and those to avoid by foreign nationals when buying real estate in Florida?
When a foreign tax resident investing in Florida, several points are to be considered to determine the most appropriate methods of acquisition:
– The different effects on trade 1031
– The impact of FIRPTA
– The impact on inheritance tax
What is a 1031 exchange and what is the impact of a source deduction under FIRPTA rules?
A 1031 exchange is a tax law that allows a real estate investor to sell a property and defer the taxation of the capital gain realized on the sale, provided that he invests the proceeds of the sale in a new “Like Kind” property and complies with the rules of section 1031 of the Internal Revenue Code.
Non-tax residents are subject to the FIRPTA regulations when selling real estate. It provides for a withholding tax of 15% of the gross selling price. Advance on taxes, it will minimize the tax actually due on the capital gain realized on the sale. If there is over-deduction, the taxpayer will be reimbursed for the overpayment after having submitted his US tax return. It is however possible to avoid this restraint through acquisition by legal structures recognized as American legal persons.
We will not discuss the ramifications of income and capital tax for each structure. We will focus on FIRPTA, when you plan to do a 1031 exchange as a tax non-resident, and on structures that would expose a foreigner to US estate tax.
You will also find in this article the example of a case where a LLC to a single partner sold a house for $ 8,700,000, made a 1031 exchange and was subject to a 15% FIRPTA withholding, subjecting the client to a reduction of $ 1,300,000 in funds exchanged in 1031, or to a reduction of $ 1,300,000 in cash flow. How did we avoid FIRPTA in this case and how could we have avoided it from the start with an appropriate legal structure?
This article also includes a study of estate problems in the United States in the case of a non-resident who owned $ 1,000,000 property there.
What legal structures can be put in place for the purchase of real estate in Florida?
There are several possibilities:
- Partnerships, including Limited Liability Companies (LLC)
- Own name acquisitions
Tenancies are not recommended for non-residents because they do not exempt them from inheritance tax in the event of death. They are, however, a substitute for the will. In English they are called "Will substitutes".
The advantage of Tenancies is that they are a solution inter vivos which avoids probate and probate procedures without a will.
C-corp, similar to French joint stock companies, have the disadvantage of double taxation and the absence of special tax treatment of capital gains: the company will pay a tax on the capital gain realized, treated as ordinary income, and the shareholders will in turn pay one on the dividends paid. On the other hand, they limit the liability of the shareholders and, being American legal persons, abrogate the withholding tax obligation of 15% on the gross sale price according to FIRPTA at the time of the sale.
Depending on the amount invested and the business strategy, a corporation may be a good choice for foreign nationals wishing to buy real estate. The analysis will be done in terms of tax consequences compared to a partnership or an LLC. A partnership being fiscally a transparent entity, the partners / members are taxed at the personal level.
Partnerships and LLC
In this article, we will focus our attention on LLCs. We will not discuss General Partnerships, Limited Partnerships, LLP, Family Partnerships and Private Equity structures. These structures are most often used in private equity investment contexts where the general partner is a different entity from the limited partner. Here the objectives are different.
Although fully-fledged legal structures, LLCs are considered to be partnerships for tax purposes: the company's tax result is taxed in the hands of the beneficiaries, who transcribe it on their own tax returns, they are fiscally transparent.
Being the most versatile legal structure, it is the most common acquisition tool for real estate in Florida.
However, as a result of tax transparency, non-resident tax members will have to file a non-resident income tax return in the United States and will be taxed on their share of the company's income. They will generally also have to declare this income in their country of tax residence and will end up taxed there. Double taxation can be avoided in the majority of cases, through tax treaties, but the risk is very present with countries which do not recognize LLCs, Canada in particular. To deal with this problem, an LLC can choose the tax status of C-corp. and be imposed as such.
The advantage of an LLC over a Corporation lies in much reduced corporate governance requirements. Members have more direct control over daily management. In short, when it comes to the choice between a partnership and a C-corp., You must measure the tax consequences of this choice for each investment. Depending on the income projected in relation to the capital gain envisaged, one tax treatment will be better suited than another.
LLCs also have the option to choose S-corp status. However, foreign nationals do not have access to them, we will not cover them in this article.
A distinction has to be made between an LLC with a single partner and one with several partners.
When it has only one member, the LLC is considered "disregarded", it is not recognized from a legal standpoint. Thus, the member is subject to FIRPTA 15% withholding, which can become problematic when you plan to make a 1031 exchange as a seller.
American legal entities, LLCs with several partners are not subject to FIRPTA and are therefore not subject to source deductions.
We strongly advise foreigners to trust trusts based in the United States for the protection of their assets and for tax reasons. Here we would need to analyze the distinctions between revocable trusts and irrevocable trusts and their respective tax ramifications. These are structures suitable for permanent residents.
Acquisition in own name
We do not recommend foreigners to own property in their own name for reasons of asset protection and inheritance tax.
They cannot claim the protection of family property either at the federal level in terms of inheritance, or at the state level in terms of protection of creditors and ad valorem tax advantages.
In terms of succession planning for foreign nationals:
Foreign nationals do not benefit from the $ 11,580,000 allowance on the estate. Succession duties are calculated and due on successions exceeding this threshold. The corresponding allowance for non-residents is capped at USD 60,000. Beyond that, their succession is exposed to rights of up to 40% of its value. They also do not benefit from the marital exemption.
Therefore, owning in your own name has no advantage for a foreigner.
As you will have understood, the choice of the structure to consider will depend on many factors.
However, from a tax, estate and limitation of liability point of view, it is not ideal for non-residents to own real estate in the United States in their own name or through a LLC to a single partner. who would not have taken a C-Corp option, that amounts to the same thing.
Tenancies are also not the most appropriate vehicle due to exposure to estate tax. The key is to avoid both US estate tax and US probate procedures.
As the tax and inheritance impacts can be considerable, the choice of structure, C-Corp. or LLC with multiple members, will need to be carefully analyzed in conjunction with your lawyer and CPA in order to achieve our three objectives: avoid probate, avoid US estate taxes, avoid FIRTPA withholding tax.
Contact our experts for a consultation :
– Alexandre Ballerini, French lawyer in real estate, companies and taxation international based in Florida.
Miami Beach: +1 305 507 9699
Manhattan: +1 212 401 7883
Washington D.C.: +1 202 525 1252
E-mail : (email protected)
– Jean-Philippe Saurat, founding partner of the accounting firm Massat Saurat + Guimond Lavallée.
Miami: 305 420 5935
New York: 212 588 8852
E-mail : (email protected)
Find some case studies below:
Case study 1 – FIRPTA & 1031
One of our clients acquired residential property with an LLC from a single partner. He sold this first property and bought a new one. In order to defer the capital gains tax realized on the first purchase, the client made a 1031 exchange with the proceeds of the sale. He was subject to FIRPTA withholding because his company was considered disregarded. The sale was $ 1,000,000. The deduction was $ 150,000. The client decided to inject $ 150,000 in order to benefit from the 1031 exchange and avoid the realized capital gain being taxed, which would otherwise have gone against the objective of the exchange. 1031. Subsequently, the client bought a house valued at $ 7,000,000. A few years later, the customer sold it for $ 8,700,000. It was again subject to a 15% holdback. Here almost 1,500,000 dollars. This time, the client did not want to inject an additional $ 1,500,000 in the 1031 exchange transaction. We were able, via a cumulative acquisition, to obtain an exemption certificate before closing, but this required long negotiations with the sellers. A multi-member LLC would not have been submitted to FIRPTA, which would have facilitated the 1031 exchange and the entire transaction.
Case study 2 – Inheritance tax
The estate of a foreign national who holds real estate, personally or through an LLC to a single partner, could, at the time of his death, pay several hundred thousand dollars in inheritance tax on a property of 1,000. 000 dollars. Without counting the costs of the homologation procedure and the legal costs.
If it were intestate, that is to say without a will, without rental or without family property, the assets could also go to an unexpected person.
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