Buying a property in the US tax efficiently

UK tax planning

In terms of UK taxes implications of owning overseas property these have been covered in other articles, however to sumarise the the best option is probably owning personally if you can ensure you are non resident for any future disposal. You would then be exempted from UK CGT.

Another option would be to occupy the property as a main residence and claim principal private residence relief and possibly lettings relief.

Next best option would be to use an offshore company and argue it was non UK resident (ie controlled from overseas). This is difficult to achieve but if successful would be the same as above, and the company would not be charged to UK tax on any gains arising on disposal. You could then become non UK resident for a single tax year in the future and extract the cash free of UK tax whilst non resident. If the company was not classed as non resident, it would be classed as a UK company, as below.

Finally, you could use a UK company. This would be automatically charged to UK corporation tax at 19% or 30% on a disposal of the properties. The only option to avoid taxes here would be to dispose of the shares in the company. If you were UK resident, you'd be subject to tax on the gain on the shares, but if you were non resident, you could sell the shares free of UK tax.

US tax planning

Non US residents, foreign entities and trusts are taxed in the US on income sourced in the US. There are two basic types of income: income effectively connected with a US trade or business (ECI) and income that is fixed, determinable, annual or periodic (FDAP). Taxpayers are allowed deductions related to ECI and are taxed at graduated rates. Gross FDAP is taxed either at a statutory rate of 30% or a lower treaty rate. Rental income is normally defined as FDAP; however, taxpayers can elect to treat the income as ECI, so income can be offset by deductions, such as interest and depreciation.

The gain on the sale of US real property used as rental property is always defined as ECI, the allowable tax rate is the same as a capital gains rate. Individuals get the best rate (usually 20%), while corporations maximum capital gains rate is around 28%. State income tax rates would also need to be taken into account. If your properties are based in Florida, this has no state tax on individuals but levies a corporate tax rate of 5.5% of taxable income. Gains from the sale of real estate developments are taxed at ordinary rates of up to 35% - 38%.

If you are non US resident you would need to consider the impact of possible gift and estate tax implications of owning real estate. Generally the best way for a foreign investor to hold US real estate is through a "pass-through" entity, such as a trust, limited liability company (LLC) or foreign limited partnership, or US partnership (unless there is a possibility of a large US Estate tax). As a general rule it is notg recommended to hold US real estate directly by a non-US corporation as the US has a branch profits tax regime that is relatively onerous (even for treaty country residents).

As stated above there is no real preferential capital gains rate on the sale of investment property with corporations as there is with individuals and there is also a possibility of a second level of taxation since gains, already taxed at the corporate level, are taxed again to the shareholder. The corporate tax rates are about 28% for capital gains and up to 35% for net operating (rental) income.

If a foreign corporation must hold real estate, it should at least form a US subsidiary corporation. That way, the subsidiary corporation would pay the tax on the gain, and its subsequent liquidation into a parent corporation is then tax free. Once that is accomplished, the foreign shareholder can liquidate the parent corporation without further US taxation. However the company ownership would not be advisable.

There is however, an advantage in US tax terms in using a traditional partnership structure or an LLC as foreign investors can use lower tax rates. If the US business is generating substantial profits the tax savings can be as much as 50% of a corporate rate. A foreign partnership or LLC structure also provides a vehicle for making US tax exempt gifts of the partnership's US real estate through transfers of the partnership interest itself since there is no US gift tax applicable to gifts of intangible interests.

Therefore in terms of US taxes the preferred route would often be to ensure that any US properties are acquired by a foreign limited partnership. It would be prudent to ensure that the foreign partnership is regarded (under local, foreign law) as an entity separate from its partners and that the death of the partner is question does not terminate the partnership.

The second best scheme is to have US LLCs directly own the US real estate and have two members that are foreign partnerships. The current taxes are passed through to the ultimate partners, but again the rates are lower than corporate rates and should one of the partners pass away, the foreign partnership interest is not a US asset.

A good option would therefore be to use a UK LLP as it is considered a foreign limited partnership for US tax purposes. Note that the the main reason for holding interest in a foreign partnership vs. a US partnership is that a US partnership with a foreign partnership must withhold on distributable net income at the highest individual rate. Another reason is that should an individual pass away, his interest in a non-US partnership is not considered a US asset for Estate tax purposes.

By using an LLP there is no tax at the entity level - the partners are taxed at regular individual rates (10% - 35%) on their distributable share of net operating income and the maximum capital gains rate is 20%.

In terms of UK taxes, holding property via a Limited partnership would also benefit from pass through taxation. Therefore any rental income derived from the property would be taxed on you personally. Similarly any gains would also be taxed on you personally. As the UK-US double tax treaty grants taxing rights to both the UK and US you would be entitled to double tax relief to relieve the US tax. If you were resident overseas you would not be subject to UK taxes, and therefore you could consider becoming resident in a tax havens to avoid taxes on any future gains. The only tax would then be the US taxes which would be at 20%.

Therefore using an LLP would have signficant tax advantages, in terms of both UK and US taxes, and could be tax effective in reducing CGT and estate taxes