Foreign Nationals Selling U.S. Real Estate for Gain – Understanding Capital Gains Tax Rules
- 1 What is Capital Gains Tax?
- 2 Foreign Individuals (Non-U.S. Persons) Catch a Tax Break
- 3 Real Estate is Treated Different
- 4 What Does that Mean?
- 5 Unreported Capital Gains or Pay Tax in Prior Years?
- 6 Want to learn more about Offshore Disclosure?
- 7 When Do I Need to Use Voluntary Disclosure?
- 8 Golding & Golding – Offshore Disclosure
- 9 The Devil is in the Details…
- 10 What if You Never Report the Money?
- 11 Getting into Compliance
The United States has very generous rules when it comes to capital gains earned by foreign nationals.
The general rule is that as long as a person is not a U.S. person (aka U.S. Citizen, Legal Permanent Resident, or former Legal Permanent Resident who did not properly relinquish their green card) they are generally not subject to US tax on capital gains (they may still have to pay tax abroad).
While this is the general rule, there is a big exception, which provides that a person who buys and sells U.S. real estate must still pay U.S. capital gains tax on the sale (presuming it was sold for gain).
What is Capital Gains Tax?
Capital gains is the idea that when you purchase an asset at one time, and sell the asset at another time, if you made profit off the sale — you should have to pay tax on the profit.
Why? Because through the sale of the asset you earned money…and since the U.S. loves to tax you, the U.S. has determined that you should have to pay tax on the earnings. But, in order to avoid losing business to other countries, the United States provides certain exemptions from US tax for foreign individuals.
Foreign Individuals (Non-U.S. Persons) Catch a Tax Break
When it involves Capital Gains, in general when a foreign person owns stocks, bonds, or other securities in the United States and they sell those stocks, bonds, or other securities for a profit, the United States does not tax these individuals on the gain. Moreover, besides the Capital Gain exclusion rules, there are equally generous tax breaks for foreign persons with portfolio income in the U.S. — they do not pay tax on most types of portfolio interest income.
*Depending on which country the foreign person resides, he or she may be subject to tax in their own country on the capital gains, but not subject two US tax.
Real Estate is Treated Different
Real estate is considered unique. Each parcel is different from another, and the laws regarding the purchase and sales of real estate are different. As such, when a person buys and sells real estate located in the United States for profit, they are taxed. The tax is similar to ECI (Effectively Connected Income) and not FDAP (Fixed, Determinable, Annual or Periodical)
What Does that Mean?
It is actually a good thing for the profit to be taxed as ECI and not FDAP. What that means is that as Effectively Connected Income, the profits are taxed as if it were business income. Therefore, a person may take certain deductions or expenses, etc.. When income is considered FDAP, it is taxed at a straight 30% withholding. Therefore, even though a foreign person with U.S. Capital Gains on the sale of real estate will be subject to US tax, they can receive the benefit of any expenses/deductions the property — which generally will significantly reduce the net effective tax rate for the sale of the real estate.
There are various definitions of what real property interest includes, and even if a person holds U.S. property in a corporation, they still may be subject to the tax (depending on the level of ownership of the business holding the real estate).
Unreported Capital Gains or Pay Tax in Prior Years?
If you did not report the tax properly in prior years, then you are out of tax compliance and may be subject to extensive fines and penalties. In order to get yourself into compliance, you may consider offshore disclosure – and presuming you are a foreign national who resides overseas and was not willful in their failure to report the tax – you may receive a complete penalty waiver for any penalties that would otherwise be due to the U.S. government.
This is generally done by applying for IRS Offshore Voluntary Disclosure.
Want to learn more about Offshore Disclosure?
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlikes the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
Call Now; We Can Help.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
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