Choosing the right entity structure might be challenging. Your accountant and an attorney should be included in any deliberations on entity structure. We’ll go through some of the benefits and drawbacks of the various structures available to investors when you intend to purchase US real estate property.
Individual Ownership
A foreign investor can buy real estate on his or her own. This involves very little setup and reduces tax and compliance
concerns. However, while owning real estate as an individual is simple to manage, it lacks the legal protection that other structures, such as a limited liability company, provide. We’ll go over this structure in more detail later.
S Corporations
For federal tax purposes, S corporations elect to pass through corporate income, losses, deductions, and credits to their shareholders. S corporation shareholders report the flow-through of income and losses on their personal tax returns and are taxed at their individual rates. This permits S corporations to avoid paying double tax on their profits.
Nonresident aliens, on the other hand, are not permitted to be stockholders in S Corporations. Furthermore, S Corporations normally do not provide real estate investors with any specific tax benefits.
C Corporations
A C corporation is treated as a separate taxpaying entity for federal income tax purposes. A C corporation’s earnings is taxed to the corporation when it is earned, and then to the shareholders when it is given as dividends. This results in double taxation. When a corporation pays dividends to its shareholders, it does not receive a tax deduction. Furthermore, stockholders are not allowed to deduct any losses incurred by the corporation.
Unless the taxpayer is a dealer, a C Corporation is rarely a desirable alternative for rental real estate for US people. Nonresidents, on the other hand, may benefit from a C Corporation if they are concerned about estate and gift taxes. This is something you’ll need to discuss with your tax professional.
Partnerships
A partnership is a group of two or more people who come together to carry on a trade or business. A partnership is required to submit an annual information return to disclose its revenue, deductions, gains, losses, and other items related to its operations, but it is not required to pay income tax. Instead, any earnings or losses are “passed through” to its partners. On his or her tax return, each partner declares his or her portion of the partnership’s profit or loss.
Partnerships are very adaptable legal structures that are frequently employed in real estate transactions. This would be the filing choice for you if you are combining your funds with other partners.
Foreign Corporations
Foreign corporations, like other entities, can be taxed on a gross or net basis. They will, however, normally be subject to the branch profits tax (BPT) if they prefer to be taxed on a net basis. Unless otherwise computed or excluded based on a tax treaty, this tax is assessed as 30% of the “dividend equivalent amount.” The entity will also have to pay regular income tax in addition to BPT. The outcome is an extremely high effective tax rate, which frequently exceeds 50%. As a result, this tax structure is frequently discouraged.
The main benefit of owning real estate through a foreign corporation is that it allows you to avoid paying estate taxes in the United States. The US estate tax is based on non-resident individuals owning US assets, however, in this case, the assets are owned directly by a foreign firm. The individual’s ownership of foreign corporation shares is not considered US property. The overseas shares are simply transmitted to the heirs after a nonresident’s death, avoiding US inheritance tax.
Limited Liability Companies (LLCs)
A limited liability company (LLC) is a business entity formed under state law in the United States. It’s a hybrid legal structure that combines the limited liability of a corporation with the tax advantages and operational flexibility of a partnership. Limited liability companies (LLCs) have largely replaced limited partnerships as the preferred vehicle for holding investment real estate.
Members are the people who own an LLC. Individuals, businesses, other LLCs, and foreign entities may all be members because most states do not restrict ownership. There is no limit to the number of people who can join. Most states also allow “single-member” LLCs, which are limited liability companies with only one owner.
Members are generally immune from personal liability for the LLC’s commercial decisions or actions. This means that if the LLC is sued or goes into debt, the members’ personal assets are normally protected. This is analogous to the liability protections provided to corporate shareholders. Remember that limited liability means “limited” liability — members aren’t always protected from wrongful behavior.
For federal tax reasons, the federal government does not recognize an LLC as a classification. An LLC must file a tax return as a corporation, partnership, or sole proprietorship. A business with at least two members can be classed as a corporation or a partnership, while a commercial entity with a single member can be categorized as either an association taxable as a corporation or a “disregarded entity,” which is a separate entity from its owner.
Knowing what entity to choose is a great strategy when purchasing a US real estate property. At the end of the day, the main goals are to minimize risk, minimize tax burden and maximize returns of our investments.
If you need further guidance on choosing a suitable entity for you, do not hesitate to contact IDM Professional Corporation CPA.
