Elements of the Purchase
Buyers often enlist the help of an agent to locate suitable property, and sellers regularly use an agent to market property. Generally, a 6% commission is payable by the seller off the purchase price, which is retained by the seller’s agent or split with the buyer’s agent if there is one.
When the buyer finds a property and wishes to purchase it, a written offer is generally made via a letter of intent (or “LOI”), which letter of intent is prepared with the assistance of buyer’s agent and/or legal counsel. The buyer and seller will negotiate and agree upon the terms of the letter of intent, including the purchase price and other general business terms of the transaction.
Following the buyer and seller’s execution of the letter of intent, the parties will negotiate and enter into a formal purchase and sale contract, which will memorialize the terms from the letter of intent and provide for all other relevant contract terms. It is typical for buyers to deposit an earnest money deposit with an escrow agent at the time the purchase and sale contract is entered into. The earnest money deposit is usually applicable to the purchase price, but may also be refundable to the buyer if the buyer terminates the contract within a certain period of time prior to the closing date.
The buyer’s obligation to purchase the property pursuant to a purchase and sale agreement is usually contingent on a number of factors, most importantly a proper inspection of the property to ensure it is in suitable condition. The purchase will also be contingent upon the seller having proper title to the property and the property not being subject to third-party liens or other third-party claims. Buyers generally require the seller to provide title insurance to guard against defects in the property’s title. The formal transfer of the property from the buyer to the seller will take place at a “closing”, which is often coordinated through an escrow agent. Both seller and buyer should be represented by legal counsel to ensure all documents are properly executed, title conveyed and funds transferred.
Most states impose certain taxes on transfers of real property. Although the seller generally pays the transfer tax, this can be negotiable.
US Tax Implications for Commercial Rental Property
Rental income is generally treated as fixed and determinable income, which is generally subject to U.S. federal tax at a 30% rate on the gross income, meaning that no deductions are allowed. This tax is imposed through withholding and no income tax return has to be filed by the non-US person.
A non-US person may elect to treat real estate rental income as income “effectively connected with a U.S. trade or business.” As effectively connected income, the non-US person is taxed on net taxable income, meaning that the taxpayer is allowed to deduct normal business expenses such as interest, normal operating expenses and depreciation. The non-US person is required to file a non-resident US income tax return. If the non-US person actively manages the property or business, it may be deemed to be engaged in a US trade or business, and the income taxed as provided by this paragraph.
In order to enforce collection from non-US persons, Congress enacted FIRPTA, the Foreign Investment in Real Property Tax Act of 1980, which generally requires a ten percent withholding on gross receipts from the disposition of real property by a non-US person. If the withholding is in excess of the actual tax due, the non-US taxpayer may file for a refund.
Non-US persons sometimes set up corporations to own US property so that the individuals do not have to file returns. In such cases the non-US person does not have to directly pay US tax. However, if a US corporation is used, any dividend would be subject to a withholding tax, which is generally capped at 15% under the tax treaty between the US and the UK (or 5% if the person owns more than 10% of the stock). If a non-US company is used, it will be subject to US tax and will be subject to a “branch profits” tax. This tax is generally 30%, but can be reduced down to the tax rate on dividends provided by the treaty.
Most states impose a yearly “property” tax, which is a tax based on the value of the property. The amount of property tax varies depending on the location of the property. The tax imposed may be challenged, generally on the ground that the tax authority’s valuation is excessive.
Depending on the location and type of property involved, there may be certain tax incentives available for real estate investment in US real property. Tax incentives may be offered at the federal, state and/or local level. Foreign investors should consult with legal counsel regarding the availability of tax incentives.
US Citizenship and Immigration Services (USCIS) administers the Immigrant Investor Program, also known as EB-5. The principal benefit of EB-5 to a foreign investor is access to an expedited process for obtaining U.S. residency while also having the opportunity to participate in a potentially attractive investment.
Under the program, EB-5 visas are set aside for foreign investors in “Regional Centers” designated by the USCIS. EB-5 also requires: (a) the creation of at least 10 full-time jobs for U.S. citizens, lawful permanent residents or other immigrants lawfully authorized to be employed in the US; and (b) a minimum investment of $1 million, or $500,000 for investments made in certain “targeted employment areas”. A targeted employment area is a rural area or an area where unemployment is at least 150% of the national average.
Upon approval of the investment by USCIS, the foreign investor becomes a conditional resident of the U.S. for two years. The foreign investor can later petition the USCIS to remove the conditions, which generally requires the foreign investor to demonstrate the full investment was made and the required number of jobs were created in accordance with the terms of EB-5.
The EB-5 application process is rigorous and the USCIS’s review and approval period can be lengthy. Foreign investors interested in the EB-5 program should consult legal counsel for more information.