Foreign Nationals in the U.S. Real Estate Market - Know Your Ground - Part 2
Exemptions - Or Not
Holding real estate jointly with a nonresident spouse can generate further issues. The general rule that property owned jointly with a right of survivorship between spouses will be included at one-half its value in the estate of the first spouse to die does not apply if the surviving spouse of the decedent is not a U.S. citizen.
Instead, the taxable value of such property is includable in the first decedent's estate in full except to the extent the executor can substantiate the contributions of the non-citizen surviving spouse to the acquisition of the property. Thus, jointly owned U.S. situs property will be fully included in the gross estate of a nonresident who provided the funds to acquire the property. Attention should also be paid to the presumptive rules applicable to individual States as to whether jointly held property is deemed to be held jointly versus as tenancy-in-common (absent express indication to the contrary).
There is typically no escape from estate taxation via a transfer between spouses as there is no marital deduction for transfers to a non-U.S. citizen spouse. In fact, these rules apply whether the decedent spouse bequeathing the assets is a foreign national or a U.S. citizen. The rationale for the tax authorities is that, absent these rules, the estate tax deferred assets transferred to a non-U.S. citizen will leave the U.S. tax net, never to be recaptured. This rule can be alleviated with the inter-vivos or posthumous creation of a Qualified Domestic Trust (QDOT), but unlike a "standard" marital trust, may only serve to achieve deferral of tax due on the death of the first spouse.
Moreover, the traps-in-waiting may begin earlier still. Initial funding of a U.S. real estate purchase may be a gift tax issue in certain circumstances. For example, take the case where a non-resident parent funds the purchase of U.S. real estate for a similarly estate tax non-resident child at college in the United States. Not only is there (albeit slight) estate tax exposure if the child owns the property, but the initial gift itself, if from U.S. sources and not planned properly, may also trigger gift tax beforehand.
While certain classes of assets, such as U.S. equities, are exempt from gift tax per se if given by nonresident donors, U.S. citizens and residents are eligible for a $1m lifetime exclusion that does not apply to nonresidents. Nonresidents are eligible for the "standard" annual exclusion amount of $13,000 per donee, but a nonresident for estate tax purposes cannot split gifts with a spouse in order to effectively double this exclusion. Both residents and non-residents are also limited to an annual exclusion amount of $133,000 on gifts to non-U.S. citizen spouses before tax applies, unlike the unlimited spousal transfer exemption that applies to transfers to U.S. Citizens. Gift tax rates are the same as those applicable to estate taxes.
Real estate held directly by the decedent foreign national also raises the prospect of requiring a probate proceeding in order to convey title to beneficiaries upon death. Such an ancillary proceeding in the United States aside from original probate in the home country may also be undesirable to the non-resident on a number of counts.
Gift tax and estate tax rules do not completely coincide and, indeed, can present certain planning opportunities as a result. The key, however, is to develop a program, if possible that reflects both gift and estate tax concerns and which is consistent with the immediate and longer term objectives of the nonresident taxpayer.
While an in-depth review is beyond the scope of this article, certain strategies to eliminate non-resident estate tax and probate concerns, such as the purchase of U.S. assets through an offshore corporation or trust structure, may be possible. However, nothing is ever that straightforward! Such techniques can also carry the disadvantage of higher establishment and maintenance fees in addition to the loss of certain income tax benefits (such as the long term capital gains rate of 15%) available if the property is held personally. As such, in order to plan effectively, a trade-off analysis is invariably required.
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In summary, the estate and gift tax regime applicable to non-residents and other non-U.S. Citizens is fraught with potential traps and decision-points.
As the acting attorney handling nonresident estates, I can attest to the fact that the combination of high taxable values and the considerable rates of tax come as a veryunpleasant surprise to beneficiaries of a nonresident estate with U.S. assets.
Understanding these issues is a salutary reminder of the need for effective advance planning in order to avoid their effects.