Here is an overview of each issue:
Taxation of Operations
A foreign person is subject to US income taxation on income that is connected with the conduct of a business in the US. Such income is subject to regular graduated rates of taxation on his net income and the foreign person is entitled to regular deductions in relation to the property operations, such as deductions for real property taxes, mortgage interest and maintenance expenses. The graduated rates for 2010 reach as high as 35% for both individuals and corporations and are scheduled to increase to 39.6% in 2011 for individuals. However, a foreign corporation also is subject to a branch profits tax at a 30% rate on its after regular corporate tax profits. If the foreign person is a mere passive owner, such as with respect to triple net leased property, his activities may not be considered the conduct of a business in the US. In that case, the foreign person will be subject to a 30% withholding tax on the gross rental income and no deductions are allowed. However, the foreign person can elect to treat such rental income as connected with a business in the US, so that he can be subject to the graduated rates and receive the benefit of deductions.
The estate of a foreign individual is subject to US estate taxation on US assets that are held by the foreign individual at his death. US real property interests are US assets for this purpose. Although Congress allowed the US estate tax to expire in 2010, it is scheduled to return in 2011 and apply at rates ranging from 18% to 55% of the fair market value of his US asset including real property.
Income Taxation Upon Disposition
When a foreign person disposes of an interest in US real property, he is subject to tax on his gain. If the US real property interest is a capital asset (not inventory held for sale to customers in the ordinary course of business) that has been held for more than one year, an individual foreign person will be subject to tax at a maximum rate of 15% (scheduled to increase to 20% in 2011) on his gain. A foreign corporation gets no tax rate benefit for such long term capital gain and therefore is subject to tax at a maximum rate of 35%.
In order to collect, in part, the US tax on a foreign person’s gain from the disposition of a US real property interest, the US requires the buyer of real property from a foreign person to withhold 10% of the foreign person’s amount realized from the disposition of the US real property interest. The foreign person must file a US tax return declaring his full gain and may apply the withheld amount as a credit against his final tax liability. There is a procedure to apply to the US Internal Revenue Service to request a reduced withholding amount if the foreign person can demonstrate that the tax on his gain is less than the 10% of the amount realized that is required to be withheld.
The previous was excerpted from Calkain Research's recent Broker Opinion Report "International Entities". View the full text here.