Nonresidents with U.S. Real Estate, IRS Inheritance & Estate Tax

Nonresidents with U.S. Real Estate, IRS Inheritance & Estate Tax

Nonresidents with U.S. Real Estate, IRS Inheritance & Estate Tax 

It is a common situation we handle often involving Non-Resident Investors in U.S. Real Estate: A Non-Resident invests in the United States, under the false pretense that because the estate tax exemption is so high (currently $11,180,000) that when they die, the real estate will pass to their family, tax-free.

Unfortunately, unlike U.S. Citizens and Legal Permanent Residents, a Nonresident does not enjoy the same estate tax exclusion. Rather, the exclusion is reduced to only $60,000.

While there are ways to plan around the $60,000 exclusion (QDOTs and Foreign Corporation owning U.S. Real Estate) that type of planning is typically not available, post-mortem.

Nonresidents with U.S. Real Estate Assets

We think it is important that foreign national, non-residents with ties (especially real estate) in the U.S. understand the basics of estate tax and planning (especially the limited exemptions) beyond mere FIRPTA issues, twofold:

  1. Many people are understandably confused about Foreign Person, Non-Resident U.S. Estate Tax responsibilities; and
  2. It oftentimes leads to IRS Foreign Reporting and Voluntary Disclosure issues.

Since U.S. Estate Tax rules vary depending on the type of property/asset/account the foreign national invests in, we will focus on Real Estate — since that is the most common investment.

Estate Tax on a Foreign Person’s U.S. Real Estate

Not only is southern California a wonderful place to live, it is a great place to invest. Southern California has a low inventory of housing, and it is known worldwide as a great investment.

For purposes of Estate Tax, a Foreign Person/Non-Resident generally includes a person who:

Is a Non-U.S.Citizen/Non-Legal Permanent Resident who does not meet the Domicile Rule for Estate Tax purposes.

U.S. Residency – Income Tax vs. Estate Tax

While the United States has the right to tax U.S. persons on their worldwide income (aka Income Tax) as well as their global estate assets (Estate Tax), the analysis is different.

While U.S. Citizens and Legal Permanent Residents are taxed on their worldwide income and international estates, the U.S. Estate Tax rules for Non-Citizens/Non-Permanent Residents are somewhat different than Income Tax rules.

U.S. Income Tax Rules

A  person (individual, not business) is considered a U.S. person when they are either:

  • A U.S. citizen
  • Legal Permanent Resident (aka Green card holder)
  • Foreign national meets the Substantial Presence Test

U.S. Estate Tax Rules

For Estate tax, the analysis is a bit different. A U.S Citizen/Legal Permanent Resident is subject to U.S. estate tax whether or not they reside in United States or outside the United States, and whether or not the property is located in United States or outside of United States (Subject to different Estate Tax Conventions and Estate Treaty rules).

For Non-Citizens, non Legal Permanent Residents, the Domicile Test is used in lieu of the Substantial Presence Test. The Domicile test is different than the Substantial Presence Test. While the Substantial Presence Test is essentially a “a Counting Days test,” the Domicile Test is a more “totality of the circumstances test.”

A Domicile is the country a person resides, with the intent to remain in that country.

Estate Tax on a Non-Resident’s U.S. Real Estate Investment

Typically, a non-resident (non-U.S. Person) purchases the U.S. Real Estate for various different reasons.

These typically include:

  • Purchasing homes in order to bring money to the U.S. (for a subsequent home sale and liquidity)
  • Purchasing a home for a child attending school in the United States
  • Investing in a REIT (Real Estate Investment Trust)
  • Purchasing a second home or vacation home
  • Purchasing a rental property to generate U.S. sourced income which may be tax-free in their country of residence

Estate Tax – The Hidden Tax

U.S. Persons

When people think of estate tax, they tend to think of the common U.S. person rules, which includes a major gift and estate tax exemption.

The gift and estate tax exemption is combined into one “bucket” (unlike GST “Generation Skipping Tax” which has a separate bucket), and currently it is set at $11,180,000.

In addition, the annual gift exclusion amount is $15,000 (increased from $14,000).

Non-U.S. Person

For a person who is a foreign national, non-U.S. Person (aka non-U.S. Citizen or Resident) who does not meet the domicile test, the Gift and Estate Tax exclusion is only $60,000.

That’s correct: the estate and gift tax exclusion for non-U.S. persons is literally not even 1% of the U.S. Person gift and estate tax exemption. This can cause a major (unnecessary) headache for many of our clients.

Foreign Resident U.S. Estate Tax Example

David Sr. is a non-U.S. person and resides in Taiwan. David Jr.. was admitted to USC, and David Sr. decides that since he and his family will be visiting David Jr. often, it would be easier for David Sr. to purchase a home (they have a significant net worth).

He purchases a $2M home in nearby Santa Monica, so his family can visit David, and enjoy sunny California. David’s children are all U.S. Citizens (his wife is a U.S. Citizen).  David had no intention of placing the home into David Jr.’s name, since he thought it would be too much responsibility for David Jr. .

In addition, due to certain local tax rules, David did not want to place the U.S. residence into his spouse’s name.

Unfortunately, David died suddenly due to complications with a surgery. The only asset David Sr. had in the U.S. was the home. Since the home was in David Sr.’s name, when he died, the U.S. situs asset will be taxed at the current U.S. Estate Tax Rates (40%) and only $60,000 of the home value would be exempt.

That leaves 40% tax on the remaining difference.

How Could the Result Have Been Different?

Aside from establishing a QDOT, forming a foreign corporation (which has other pitfalls) or other unnecessary tax planning scenarios, all David had to do was purchase the home in a different person’s name who was a U.S. Citizen, such as his spouse or child (U.S. Citizens).

David could have gifted the money to a U.S. person, and the U.S. person would file a Form 3520.

Even if the other person (a U.S. Citizen) had died suddenly instead, and the asset was under his or her name, there would be no estate tax (unless the entire estate was worth significantly more) — since a U.S. person is taxed on their worldwide estate subject to various convention and estate tax treaty rules.

But the Spouse and Children are Not U.S. Residents?

While they do not live in the U.S.,they are U.S. citizens, so the mere fact that they live or ‘resident’ outside of the United States does not make them “Foreign Residents” for estate tax purposes. Since the wife and children are U.S. Citizens, any one of them would have received the benefit of the full $11,180,000 exemption.

It is a double-edged sword: One the one hand, the U.S. gets to tax the wife and children on worldwide assets (whereas it can only tax David Sr., a non-U.S. Person for Estate Tax, on his U.S. situs), but unless his wife or children are worth more than than the exclusion amount, there would be no U.S. Estate Tax.

Other Common Related Issues to Watch Out For

Since David’s wife and children (all U.S. Citizens) have not been filing their U.S. Tax Returns properly. Like many of our clients, they thought there were different Tax and Reporting rules, since they reside outside of the U.S., only have passive income (they have no earned income), and pay tax in their current country.

Now, they have the IRS to deal with.

IRS Foreign Account, Assets and Investment Reporting

Since the rest of David Sr.’s brood are U.S. Citizens, they should have been disclosing their foreign money to the IRS, including:

  • Bank Accounts
  • Financial Accounts
  • Investment Accounts
  • Real Estate
  • Foreign Business 

Since the family was not properly reporting, they may find themselves subject to IRS fines and penalties unless they properly get into compliance.

With that said, there are many IRS Amnesty Programs in place that may assist them win reducing or eliminating these penalties.

Golding & Golding, A PLC

We have successfully represented clients in more than 1000 streamlined and voluntary disclosure submissions nationwide, and in over 70-different countries.

We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.

IRS Offshore Voluntary Disclosure Specialist

IRS Offshore Voluntary Disclosure Specialist

Golding & Golding: Our international tax lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70+ different countries. Managing Partner Sean M. Golding is a Board-Certified Tax Law Specialist Attorney (a designation earned by < 1% of attorneys nationwide.). He leads a full-service offshore disclosure & tax law firm. Sean and his team have represented thousands of clients nationwide & worldwide in all aspects of IRS offshore & voluntary disclosure and compliance during his 20-year career as an Attorney.

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. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
IRS Offshore Voluntary Disclosure Specialist