Foreign Investor Real Property Tax Act (FIRPTA)

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Foreign Persons Involved in U.S. Real Estate Transactions

With the increasing globalization of trade and investments, foreign ownership of U.S. real estate continues to grow. Consequently, U.S. real estate professionals and rental agents/property managers are encountering an increasing number of situations that involve foreign persons acquiring U.S. real estate as a part-time residence, for investment or in some cases to conduct a U.S. business. The U.S. tax rules that apply to ownership and dispositions of U.S. real estate by foreign persons are different in some important respects from the rules that apply to U.S. persons.

This article discusses the U.S. federal income tax rules that U.S. real estate professionals must know to properly deal with foreign investors in U.S. real estate, and to avoid certain personal liabilities for improper U.S. federal income tax compliance. The first part of this article covers the rules that determine whether an individual or entity is to be treated as U.S. or foreign. The second part discusses compliance with the Foreign Investment in Real Property Tax Act (FIRPTA) for sales by foreign persons of U.S. real property interests (“USRPI”). The third part provides the fundamentals of U.S. federal income taxation of foreign investors with U.S. rental income.

Definition of Foreign Persons

Because a number of U.S. federal tax rules differ when a foreign person is involved or apply only to foreign persons, it is important for a U.S. real estate professional to understand when an individual or entity is considered foreign for U.S. federal income or estate tax purposes.

A nonresident alien is defined for federal income tax purposes as an individual who is neither a U.S. citizen nor a resident of the United States within the meaning of section 7701(b) of the Internal Revenue Code (the "Code"). An alien individual is a resident of the U.S. for federal income tax purposes if he or she meets either of the two tests under section 7701(b):

The first test is the “green card” test. If an alien has been admitted for U.S. permanent residence (i.e., has a green card) at any time during the calendar year, the alien is a resident of the United States and is taxed on his or her worldwide income, the same as a U.S. citizen. Otherwise, U.S. immigration status generally is not controlling or relevant for U.S. federal tax purposes. In this respect, the U.S. differs from many foreign countries, in which immigration and tax status are integrated, a difference that frequently causes confusion.

The second test is the substantial presence test. Under the substantial presence test, an alien individual is a resident for U.S. federal tax purposes if the alien is physically present in the U.S. for 183 days or more during the current calendar year. Alternatively, if the alien is physically present for at least 31 days during the current year, the alien may be treated as a U.S. tax resident in the current year under a three-year look-back test in which each day of presence in the current year is counted as a full day, each day of presence in the first preceding year is counted as one-third of a day, and each day of presence in the second preceding year is counted as one-sixth of a day. If the total of such days is 183 days or more, the alien may be a U.S. tax resident for the current year unless certain exceptions apply and the alien files certain required information with the IRS to claim the benefit of any relevant exception. As with the green card test, if an alien is a U.S. tax resident under either version of the substantial presence test, the alien is taxed on his or her worldwide income, the same as a U.S. citizen.

If the alien is from a country that has an income tax treaty with the United States, the treaty may act to change these results, subject to certain required filings with the IRS to claim the treaty benefit. Also, in the first year that an alien might be subject to the substantial presence rule, it may be difficult to tell if the alien actually will become treated as a U.S. tax resident for that year.

A foreign corporation is a corporation that is not incorporated in the United States. The rules for other types of entities are more complex. Also, if an eligible foreign entity has filed a “check-the-box” election for U.S. federal tax purposes, its U.S. federal income tax treatment will differ from the norm for that type of entity; for example, a foreign corporation with a single owner may (if eligible) elect to be disregarded for U.S. federal tax purposes, or to be treated as a partnership if it has more than one owner. In either case, the resulting U.S. taxpayer is the owner or owners, who themselves may be foreign or domestic for U.S. federal tax purposes. Similarly, a foreign unincorporated entity might elect to be taxed as a foreign corporation for U.S. federal tax purposes.

Tax Information For Foreign Owners of U.S. Real Estate

Foreign Investor Real Property Tax Act (FIRPTA)