For many people, the acquisition of a second home abroad is the realisation of a long held dream. However, without proper financial advice, that dream could easily turn into a nightmare. Experience has shown that many people forget to consider the tax implications of buying property abroad until it is too late. Advice at an early stage from an objective view point can save not only tax but also the time and trouble of trying to unravel complicated arrangements at a later stage. We have given a brief summary of some of these below in order to highlight the relevant areas.
United Kingdom Residents
As a tax resident of the UK, if you own a second property in the USA and rent it out when you are not using it, you will have a UK tax liability on the rental income. It may be possible to reduce this claiming for expenses such as maintenance, agents fees, and interest paid on a loan to finance the purchase of the property. However, adjustments may require to be made to deductions available to reflect the amount of private use of the property. Normally, you will be able to claim relief for any US tax paid against UK tax due on the rental income.
If you sell the property, you will normally be liable to UK capital gains tax on the difference between the price originally paid and the sales proceeds. Deductions may be available for selling expenses and money spent on improvements. US tax paid on the gain will normally be creditable against your UK capital gains tax liability. The value of the property (less any loan outstanding on it) will normally form part of your estate for UK inheritance tax purposes. It will therefore need to be included in any account rendered to the UK authorities on your death. If the property is given away in your lifetime to another UK resident individual, then providing you survive seven years from the date of the gift, no inheritance tax will be due.
United States of America Taxes (all nationalities)
Income Taxation of Foreign Investment in US Real Estate. In general, a non-US resident individual is subject to US income tax on income derived from rental real estate activities and dispositions of real property. The foreign investor in US real estate is subject to a tax on either a gross basis (i.e. gross income without allowance of deductions) or on a net basis (i.e. gross income less allowable deductions). The manner in which the foreign investor is subject to US taxation depends on the specific facts of the investor's US real property rental activities or whether the investor makes certain elections for US tax purposes. US state income taxes may also apply depending on the state in which the real property is situated. The foreign investor is generally required to file a US (and possibly state) income tax return associated with US real property rental activities.
US Gift Tax. Us gift tax generally applies to a non-US resident individual that makes a direct or indirect transfer of real property situated within the US. The gift tax applies to the donor of the property. The tax is applied on the fair market value of the gifts reduced by certain deductions. In addition to the gift tax, generation-skipping transfer tax considerations need to be taken into account prior to gifting US real property.
US Estate Tax In general, non-US resident individuals must include the value of real property situated within the US in their gross estate for US estate tax purposes. Certain planning techniques may be available to foreign investors to defer US estate tax on property transfers to a surviving spouse. The foreign investor will also need to consider whether any US state inheritance tax may apply to any real property transfer at death.
Local Taxes The foreign investor in US real property must also consider local taxes that may apply as a result of owning US real property. Among the taxes to be considered are wealth tax, property tax, sales tax, tourist development tax, resort tax, tourist impact tax, convention tax, etc. Local taxes may vary from state to state in their application. The cost of local taxes should be shown on the sales brochure.
Acquisition taxes Certain US states may impose a conveyance tax or a documentary stamp tax on any instrument that conveys an interest in real property. In addition, under under US income tax law (and possibly state income tax law as well), the buyers of US real property is generally required to withhold a portion of the sales proceeds to remit to the US (and possibly state) tax authorities as income tax withholding.