US Non-resident Tax Traps - A Simple Property Transfer is Never Simple
Written by James Baker May 7th, 2018. 
I'm writing this report today to touch on an issue I've been seeing often. I work with international (Non-resident) real estate (RE) investors and I consult on US tax compliance. I receive many questions from prospective clients who want to change the structure of their businesses. The two most common situations are investors moving assets out of a corporation or into a corporation. There are different reasons an investor may want to do this. The most popular are –
  - To "lower tax" Corporate capital gains tax is ~21% and the personal/partnership capital gain tax rate is ~20%.
  - The investor holds real estate but doesn't like filing a personal tax return (Form 1040NR).
  - The investor wants to shift the legal liability to the corporation and away from personal assets.

Before we get into the nitty gritty, I want to reiterate that most of my clients are US nonresidents (NR). As a NR, there are different rules that apply depending on the nature of the transaction. Here I will review the consequences of a US Non Resident individual moving property both into, and out, of a US Corporation.

Corporation owns Real Estate and transfers it to the NonResident shareholder
The Corporation has been filing Form 1120 each year to report the rental activity of the property. The shareholder wants to sell the property himself, to use a lower tax rate. All the shareholder has to do is move the title out of the Corporation. Unfortunately the IRS is aware of this, and does not make it easy.
The taxable event starts with the title transfer. The most common ways I see titles transferred are with Warranty Deeds and Quit Claim Deeds. No matter which deed you use, the transfer of property is a deemed sale for tax purposes. This “deemed sale" causes a taxable event to both the corporation and the shareholders.
As a result of the transfer, the corporation will pay a tax rate as high as 21% on the gain as if it had sold the property. We compute the gain by taking the Fair Market Value (FMV), minus the corporation's basis in the property [1]. The shareholder that receives the property also pays tax on the full FMV of the distribution. The distribution is a dividend to the extent that the corporation has accumulated earnings and profits [2].

Have you heard about FATCA? FATCA stands for the Foreign Account Tax Compliance Act. If you want a detailed review, Deloitte put together a great FAQ you can check out here. Without getting into too much detail, the US Corporation must withhold 30% of the dividend. The withholding is then remitted to the US government and claimed on the personal tax return of the shareholder as a credit. If there is a tax treaty between the US and the shareholder’s home country, it can reduce the rate of withholding. See the Form 1042 series to learn more about the tax filings required.
This isn’t an extra tax, but it accelerates the timing of the cash remittance. So if you are keeping track, this simple property transfer with a Quitclaim deed has been costly.
The corporation pays tax on the gain
The shareholder pays tax on the distribution received
The corporation remits 30% to the IRSfor the distribution. This must occur within 7 days of the transfer.
If any of the events are not accounted for, there is exposure for IRS penalties and interest on top of all the taxes. Yikes.

NonResident individual owns Real Estate and transfers it to a Corporation
In this instance, you have a US nonresident with rental real estate in his name, located in the US. The individual has been reporting the rental income and expenses on Form 1040NR each year. The individual has also elected to treat the property as a US business [3]. This is a necessary election to allow the deduction of expenses and is often not included.
The individual wants to move the property into a Corporation for estate tax purposes. This is something that is very common so pay attention.
The transfer of title via a General Warranty Deed results in a deemed sale and a taxable event. The individual needs to pay tax on the gain at a 20% rate if he owns the property longer than one year. We calculate the gain by taking the FMV of the property, less the original cost. We must add back depreciation used in prior years as well.

In this scenario the corporation does not pay an income tax. But that does not mean there is nothing to do. Similiar to FATCA, the Foreign Investment in Real Property Tax Act (FIRPTA) has rules that apply here.
If a non-resident individual disposes of US real property, the buyer (Corporation) must to deduct and withhold 15% of the FMV [4]. For example, if the individual transfers a property with a FMV of $100,000 to a corporation, the corporation must remit $15,000 to the IRS. This is tax withholdings for the individual. This withholding is a required by FIRPTA. As usual, there are IRS penalties enforced on non-compliers.
If there is no gain on the transfer, the individual can claim a credit for the withholdings and have them refunded with the annual tax return filing. The timing of the payments and the upfront cash required are what make this problematic. To that end the IRS has issued relief. There are options for reducing or eliminating withholding requirements in certain scenarios. The basic qualifications are:
  - The absence of a gain on the sale. There are other exceptions to withholding, but in my experience they don’t often apply.
  - If there is no gain and the transfer qualifies, the taxpayer must file Form 8288-B to request a withholding certificate.
  - Within 90 days the IRS should respond and the parties can proceed with the transaction.

What this all means – 
A little disclaimer: this article is not tax advice. It is an overview to highlight the required compliance on two simple transactions. Each of the details and rules I reference above are over simplified to make this report easier to read. If you are a US non-resident, follow up with your tax professional to discuss any inte and only use this report for a basic understanding of the issues.
I can say with certainty that of all the clients I’ve seen in my career, there has never been an exact duplicate set of facts and circumstances. The smallest change in facts completely changes my advice and the actions required.
If you, your clients, or friends are a US Non-resident I implore you to seek professional tax advice before investing in the US market.
In Summary
If you transfer a deed it is a deemed sale for tax purposes
FATCA applies to US entities that pay Non-resident entities
FIRPTA applies to US Non-residents that invest in real property
Speak with your tax advisor before investing in the US

[1] I.R.C. § 311(b).
[2] I.R.C. § 301(c)(1), 316.
[3] I.R.C. § 871(d).
[4] I.R.C. § 1445(a).

James Baker, CPA

Jim Baker helps international investors and businesses lower their US income tax bill with custom tax plans. We help our clients through the whole process and work hard to make things super simple to understand.
If you're interested in lowering your tax bill and ensuring that your assets are safe from the IRS, then definitely reach out and request a free strategy session today -
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