This guest blog is contributed by Paul Queeney and Nicole Queeney Tran of SBT Tax, a full-service tax and accounting firm based in Southern California.
Crowdfunding can be an attractive vehicle by which foreign nationals (non-U.S. citizens or residents) can invest in U.S. real estate. It is often helpful when such foreign investors form a U.S. entity (like a corporation); reporting requirements for the crowdfunding company are simplified, and the investors can set up a legal structure that provides some protections and helps to minimize overall taxes.
Crowdfunding companies like Realty Mogul have enabled large numbers of unrelated investors to take advantage of smaller minimum investments amounts to, together, make significant investments in commercial real estate properties that may have previously been inaccessible to such investors. Bringing together all these smaller investors is not easy, though, and since crowdfunding organizations already deal with a large number of investors for any one particular investment, it simplifies things when those companies can deal directly with U.S. persons or entities (such as corporations).
If a U.S. crowdfunding company can deal with foreign investors through U.S. companies (owned by those foreign investors), that arrangement greatly reduces the amount of reporting that the crowdfunding company is required to make to the U.S. government. Setting up a U.S. company can also greatly benefit an individual foreign investor; a properly structured investment vehicle can minimize overall income taxes and, depending on how the entity is set up, minimize both the annual fees and reporting that may be required as well as minimize any estate (inheritance) and gift taxes that might apply. The legal entity can also provide privacy; in some states, the true owners may not have to be made part of the public record -- for example, if nominee shareholders and directors are used or the company is financed by debt instrument. Entities also provide legal protection; in most states, legal liability stops at the entity level, and the owner(s) are not personally liable in the event of a lawsuit.
An example structure could be as follows:
- The foreign investor sets up a legal entity (ForCo) in his home country; note that certain business entities may be better suited for a particular investor’s goals;
- The investor also sets up a U.S. company (InvestCo) that is wholly owned by ForCo;
- Then, InvestCo invests in the crowdfunding entity (CrowdCo).
In the U.S., corporations are often the entity of choice for foreign investors. Limited liability companies (LLCs) can also be attractive vehicles, but in order to gain the benefits discussed above, the LLC must elect to be taxed as a corporation -- and it can take much longer to get a tax ID number for an LLC (three months, instead of one week for a corporation). Each possible structuring arrangement has pros and cons; an investor should consider carefully the various options.
Realty Mogul focuses on properties that provide prompt cash flow; but many real estate investments often have no taxable income in the early years, due to interest payments, depreciation, improvements, and other expenses. In those cases, if the proper tax election is not made, the tax burden can be quite substantial; it could be that no expenses would be allowed, and taxes might be withheld at the standard 30% rate on all yearly income. It is important to distinguish between profit and cash flow; for our purposes, cash flow is equal to income (usually rent) minus expenses paid (mortgage interest, maintenance, property taxes, management fees, etc.) less income taxes based on the taxable profit. Taxable profit is equal to the cash flow minus depreciation, which, for commercial properties, is generally equal to the value of the building divided by 39.5 years. A building worth $1 million, for example, would generate $25,316 of depreciation yearly -- cash flow that one doesn’t have to pay taxes on until the building is sold.
When the real estate in which CrowdCo has invested is sold, and cash is distributed to the investors, InvestCo will have to pay capital gains tax at a rate between 15% and 35% (depending on the amount of capital gains). At the moment that CrowdCo distributes this cash, the investor’s InvestCo ceases to be a U.S. real property holding company – which means that InvestCo can be liquidated and the cash distributed to ForCo without further US tax liability. Having a foreign company (ForCo) in this arrangement can provide additional benefits; for example, if the investor dies before CrowdCo is able to distribute all of the available cash, any change of ownership of ForCo (by inheritance or otherwise) would take place in the investor’s country -- and that change of ownership would have no U.S. tax consequence (i.e. no additional payments).
U.S. tax professionals like SBT Tax can help investors set up the various phases of a foreign national’s investment, including:
- Selection and creation of the entity type (and which state to create them in), and handling all of the related formalities (articles of incorporation and other formal requirements).
- Obtaining the international tax identification number (ITIN) required by the U.S. government.
- Selection and creation of a comprehensive investment structure – this may include creating multiple entities (including a corporation in a foreign investor’s home country) and the proper tax classification elections.
- Setting up a banking relationship with a US bank.
- Filing all annual tax and information returns (state and federal) as well as required state entity documents (e.g. annual reports).
Fees for these services vary, but can typically range from $4-10,000 for the initial set-up work with annual administration fees in the $1-2,000 range.
Tax advisers like SBT Tax know that it is important to get to know foreign investors and understand their particular issues in determining how to make investments in the U.S. It is also important that these complex business decisions can be explained in plain language -- in the investor’s language!
SBT Tax is a year round, full service tax, accounting and financial services firm located in Orange County, CA. It combines the breadth of knowledge normally found in a large firm with the care and attention you expect from a smaller firm. SBT has multi-lingual staff, particularly those who are knowledgeable in working with the Asian community. SBT is accustomed to helping foreign investors enable their investment goals with respect to U.S. investments. For more information, please contact Nicole Queeney-Tran at 1-714-221-8080, or by e-mail at firstname.lastname@example.org.
IRS Circular 230 Notice: Unless specifically stated otherwise, any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of: (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.