The “Best” Ways To Own Florida Real Estate For Foreign Buyers

WHAT IS THE “BEST” WAY FOR A FOREIGN INDIVIDUAL TO OWN FLORIDA REAL ESTATE?

If you ask a dozen accountants, attorneys, or investment advisors about the best manner for foreign buyers to take title to the property in Florida you are most likely to receive twelve different responses. Unfortunately, this is truly one instance where one size does not fit all and a careful examination of how the property will be used should be examined as well as the buyer’s goals and objectives.

I submit, the top six goals (not in any order) for any foreign buyer would be as follows:

1. Minimize the income tax rate if the property is to be rented.
2. Minimize the capital gain tax rate at the time the property is eventually sold.
3. Obtain the maximum benefit under the tax treaties of the home country and the United States.
4. Avoid probate upon death.
5. Avoid guardianship upon incapacity.
6. Minimize or eliminate estate tax upon death.

Unfortunately, it is nearly impossible to achieve each goal as virtually every option to consider offers its own advantages and disadvantages. Below is a brief summary of most of the common options a foreign buyer should consider when determining the best solution for taking title to their newly acquired property.

INDIVIDUAL OWNERSHIP IS THE MOST COMMON METHOD TO HOLD PROPERTY.

PROS:

The good news is that during the owner’s lifetime the first three objectives set forth above can be met.

CONS:

The bad news is that the latter objectives four and five will not be met and can cause serious issues in the event of death, namely probate and estate tax.

1. Income tax is generally reported at the lowest rate (provided there are offsetting expenses). However, if the foreign owners use that property for personal purposes for more than 14 days of 10% of the annual number of days the property is rented the deductions for income tax purposes will be substantially limited. Tax deductions are limited to the income generated from the property. As a result, the owner cannot write off tax losses for U.S. income tax purposes if he has other income.

2. Capital Gain upon sale is favorable at the present rate of 20%. The only caveat to this is depending on the length of time the property is held, a portion of the gain may be taxed at a higher recapture rate (25%) if the property had previously been depreciated for capital gain purposes.

3. Double taxation is avoided. As long as a separate Tax I.D. number is not created, upon sale, under the vast majority of the tax treaties presently in place, all capital gain paid in the United States will be credited against capital gain due in the country of origin. Therefore through individual ownership double taxation can be avoided.

4. Probate may initially be avoided if property is held jointly by husband and wife, however, upon the death of the second spouse, or if simply individually owned, a probate will be required to be brought to transfer title to the children and/or other beneficiaries of the deceased. Unfortunately, a will does not avoid probate.

   Probate is costly. Statutory guidelines suggest the fee for the personal representative is 3% of the estate. The fee for the attorney is 3% of the estate. Filing fees, including publication fees, typically are 1% for a potential total of 7%. To make matters more complicated, the personal representative must be a blood relative or resident of the State of Florida and appointed by the Florida court and the process typically takes one to two years.

5. Guardianship is unlike jointly owned property which only requires probate upon the death of the second spouse. If either party is incapacitated mentally or physically or if individually owned, guardianship will be required to be brought if a property is sold. One exception is if a duly executed Durable Power of Attorney is signed meeting all the ridged Florida requirements before an individual is incapacitated.

   Guardianships are consuming and very costly. Most contracts only provide the seller a 30-day opportunity to clear the title. If guardianship is not brought before the property is listed, it may be a challenge to find a patient buyer.

6. Estate/Gift Taxes. Unlike most countries, the U.S. has an estate tax that taxes citizens on the transfer of property upon death. The tax can be brutal, under certain
   circumstances for high-net-worth foreign buyers who have not done the proper planning. The tax takes into consideration everything an individual owns wherever located, at the date of death. The fair market value (on the date of death) is used, not the value when the property was acquired. The total of all of these assets is referred to as the “Gross Estate.” This includes cash and securities, real estate, insurance, and other assets. Then certain deductions are made against the Gross Estate such as mortgages and other debts, estate administration expenses, and qualified charities. The remaining value of the asset is referred to as the Taxable Estate and the estate tax is then levied against the Taxable Estate.

   The present estate tax exclusion amount is 12.06 million in 2022 for an individual and 24.12 million for a couple making this a moot issue for the vast majority of individuals. However, the estate tax rate is 40% for transfers that exceed this amount.

   Unfortunately, foreign citizens who are not domiciled in the U.S., but who own property in the U.S., are also subject to the U.S. estate tax. The U.S. estate tax is imposed when three criteria are met:

   1. The Foreign Citizen must have U.S. assets (including real estate and U.S. stocks.
   2. The value of the total assets exceeds $60,000.00.
   3. The value of all worldwide assets exceeds $5,340,000.00 if single and $10,680,000.00 if married.

   As a result high net worth foreign citizens that own a vacation home in Florida (or any other U.S. state) with a value at the date of death in excess of $60,000.00 may be subject to U.S. estate taxes. The determination of which property is situated in the U.S. is critical since only such property is subject to U.S. estate tax. However, the tax is based on the percentage of U.S. assets against foreign citizens' worldwide assets. The greater the percentage of U.S. property creates a greater possibility of a U.S. tax.

   Unfortunately, percentages of U.S.-owned property vs. worldwide assets are always subject to fluctuation and are difficult to predict what they will be at the date of death. Therefore, it is very easy for a high net worth individual to unexpectedly encounter an estate tax. Once the tax does apply, it must be paid to the I.R.S. within nine months, regardless if the property is sold.

OWNERSHIP BY A LIMITED LIABILITY COMPANY

Many of the issues associated with individual ownership also apply with taking title in an LLC, however, there are also many distinctions.

PROS:

• Income Tax is treated favorably at the lowest possible rate since interest held in an LLC is taxed individually. However, both the individual and the LLC must file an annual U.S. income tax return.

• Capital Gains upon sale is also treated favorably at the lower individual rate of 20%.

• Probate typically can be avoided in an LLC provided the LLC is not owned by one individual and there are other members of the LLC, title remains in the limited
  liability company and probate of the LLC property will not be necessary.

• Guardianship typically can be avoided, if there is more than one Managing Member of the LLC at the time the LLC is created.

CONS:

• Income Tax is treated favorably at the lowest possible rate since interest held in an LLC is taxed individually. However, both the individual and the LLC must file an annual U.S. income tax return.

• Capital Gains upon sale is also treated favorably at the lower individual rate of 20%.

• Probate typically can be avoided in an LLC provided the LLC is not owned by one individual and there are other members of the LLC, title remains in the limited
  liability company and probate of the LLC property will not be necessary.

• Guardianship typically can be avoided, if there is more than one Managing Member of the LLC at the time the LLC is created.

• Double Taxation may be an issue. Because a separate Tax I.D. is required for an LLC, many countries treat an LLC as a corporation, which often results in higher capital gain tax rates as well as a mismatch of income taxation between the foreign country and the U.S. resulting in double taxation.

• Estate/Gift Taxes. Unfortunately, since the same income tax rules apply to an LLC member as to an individual, the same estate tax issues which apply to an individual also
  apply to a member of an LLC upon death. As a result, an LLC does not escape estate tax.

OWNERSHIP BY A FOREIGN CORPORATION

In years past, foreign corporations were frequently used to own U.S. property. However, this has fallen out of favor, particularly with Canadians in recent years due to a policy change set forth by Canada Revenue Agency effective January 1, 2005. It has been determined that a taxable shareholder benefit is created if the property held by a corporation was made available for the personal use of the shareholder. The value of the taxable benefit is determined by either, the fair market rent approach or the imputed rent approach.

Under the fair market rent approach, the taxable benefit will be the fair market value rent for the property less any consideration paid by the shareholder to the corporation for the use of the property. Under the imputed rent approach, the taxable benefit it’s calculated by the greater of the cost and the fair market value of the property multiplied against the Canada Revenue Agency’s prescribed interest rate, the operating costs related to the property paid by the corporation, less any consideration paid by the shareholders for the use of the property. As a result, it is no longer desirable to own property intended for personal use inside a Canadian Corporation. Many other countries have similar rules which make owning property in a foreign corporation to be less than desirable.

PROS:

• Probate is avoided through ownership in a corporation. Good news is the time and expense of costly probate in the State of Florida, including the appointment of a personal representative can be avoided through corporate ownership.

• Guardianship can also be avoided, provided there is more than one shareholder.

• Estate/Gift Taxes. Fortunately, if real estate is held by a foreign corporation estate, estate taxes are avoided and do not come into play even though the property is located in Florida it is deemed held outside the United States and not subject to estate tax.

CONS:

• Probate is avoided through ownership in a corporation. The good news is the time and expense of costly probate in the State of Florida, including the appointment of a
  personal representative can be avoided through corporate ownership.

• Guardianship can also be avoided, provided there is more than one shareholder.

• Estate/Gift Taxes. Fortunately, if real estate is held by a foreign corporation estate, estate taxes are avoided and do not come into play even though the property is located in Florida it is deemed held outside the United States and not subject to estate tax.

• Income tax rates for a foreign corporation are not favorable and in fact, can be brutal. The tax imposed can vary but typically most corporations are taxed in the 30% to 40% range. To make matters worse, even after the corporation pays the tax, if funds are distributed to shareholders, said distribution is subject to a 35% withholding tax and the shareholders must also pay tax on any income they receive.

• Capital gainThe rate has been reduced to 21% making this more favorable than it had been in the past.

• Double taxation, as referenced above, generally occurs when the corporation is taxed as well as its shareholders.

OWNERSHIP THROUGH AN IRREVOCABLE TRUST

Irrevocable Trusts can be an excellent tool for high net worth individuals who have worldwide assets in excess of $5,340,000.00 if single and $10,680,000.00 if married who otherwise would be subject to estate tax.

Unfortunately, the difficulty in establishing an irrevocable trust, is that the buyer must be willing to part with control of the interests held by the trust. The buyer supplies the cash for closing, and is known as the Grantor of the trust, however, it is typically the children who are the beneficiaries. However, this vehicle is primarily for asset protection and estate tax avoidance.

PROS:

• Income tax rates are treated similar to individual ownership at the favorable low rate. However, the beneficiaries and not actually the individual who contributed the
  purchase price, receive the income.

• Capital gain upon sale is also treated very favorable for beneficiaries and is at the low individual rate of 15%.

• Double taxation can be avoided when utilizing an irrevocable trust as long as Tax I.D. numbers are obtained for the individual beneficiaries and not the trust.
  Furthermore, the vast majority of tax treaties provide a credit in the home country against the tax paid in the U.S. when held be an irrevocable trust.

• Probate can be avoided through the use of an irrevocable trust. Even though the grantor passes away, the grantor retains no interest to probate. Additionally, addition beneficiary designations may be made within the trust to provide for contingent beneficiaries much in the same manner as beneficiaries under an insurance policy,

• Guardianship can be avoided through the use of a Revocable Trust. Typically, successor trustees are listed in advance in the event of incapacity.

• Estate/Gift tax can be avoided provided the buyer contributes cash (preferably from a Non-U.S. Bank Account) to the irrevocable trust for the purchase of the U.S. real property. As a result, the foreign buyer will not be subject to U.S. gift tax for the cash contribution. In regards to estate tax, the trust may be subject to U.S. estate tax if one of the beneficiaries of the trust (as opposed to the grantor/buyer) is the one to pass away. As a result, when creating an irrevocable trust the grantor/buyer is hedging bets on who may be the first to die.

CONS:

• Income tax rates are treated similar to individual ownership at the favorable low rate. However, the beneficiaries and not actually the individual who contributed the
  purchase price, receive the income.

• Capital gain upon sale is also treated very favorable for beneficiaries and is at the low individual rate of 15%. to 20%

• Double taxation can be avoided when utilizing an irrevocable trust as long as Tax I.D. numbers are obtained for the individual beneficiaries and not the trust.
  Furthermore, the vast majority of tax treaties provide a credit in the home country against the tax paid in the U.S. when held be an irrevocable trust.

• Probate can be avoided through the use of an irrevocable trust. Even though the grantor passes away, the grantor retains no interest to probate. Additionally, addition beneficiary designations may be made within the trust to provide for contingent beneficiaries much in the same manner as beneficiaries under an insurance policy,

• Guardianship can be avoided through the use of a Revocable Trust. Typically, successor trustees are listed in advance in the event of incapacity.

• Estate/Gift tax can be avoided provided the buyer contributes cash (preferably from a Non-U.S. Bank Account) to the irrevocable trust for the purchase of the U.S. real property. As a result, the foreign buyer will not be subject to U.S. gift tax for the cash contribution. In regards to estate tax, the trust may be subject to U.S. estate tax if one of the beneficiaries of the trust (as opposed to the grantor/buyer) is the one to pass away. As a result, when creating an irrevocable trust the grantor/buyer is hedging bets on who may be the first to die.

• Complete Loss of Control. An Irrevocable Trust, by definition is irrevocable and no modifications can be made. The individual who funds the purchase may benefit residing on the property but is not the beneficial owner.

OWNERSHIP THROUGH A MODIFIED FLORIDA LAND TRUST

Florida land trusts have flown under the radar for most attorneys and particularly accountants. They are seldom mentioned in national journals simply because land trusts only exist in a small handful of states. At one point, Florida Land Trusts required a corporate entity to serve as trustee, a requirement which no longer exists. Today they are much more flexible.

Ironically, there has been virtually little case law and tax decisions pertaining to land trusts. Until recently, land trusts were used primarily as a stealth tool to disguise the ownership interest of the property owner. However, if drafted properly, a Florida Land Trust can meet all six objectives of a foreign citizen owning property in the United States. Unlike irrevocable trust, the grantor can also serve as the trustee and the beneficiary. As a result, there is never any loss of control.

PROS:

• Income Tax. As demonstrated above the best way to own property for income tax purposes is through individual ownership which provides the lowest income tax consequences. Fortunately, a land trust entitles the owner/beneficiaries to receive individual taxation treatment. When creating this trust it is important to reference I.R.C. 674-677 which provides that the beneficiares of the trust shall be treated as the owner for tax reporting purposes.

• Capital Gain. As a result of individual tax treatment, the owner(s) of a land trust receive the favorable and lowest rate of capital gain (presently 20%).

• Double Taxation. Pursuant to Section 1.671-3(2)(1) of the Internal Revenue Code no additional separate Tax I.D. is needed for the trust. As a result under the vast majority of tax treaties, upon sale, similar to an irrevocable trust the seller (owner) of the trust will be able to receive credit for any capital gain tax paid in the U.S.

• Probate, similar to an irrevocable trust is totally avoided through the use of a land trust. Even though the owner/beneficiary may pass away the title remains in the trust and there is nothing the probate court needs to do to transfer title to beneficiaries. The trust already provides for subsequent beneficiaries similar to a beneficiary designations found within a life insurance policy.

• Guardianship, similar to an irrevocable trust provide for the trustee to sign any necessary documents, including deeds of conveyance. If one trustee is incapacitated, a successor trustee may act avoiding the need for a guardianship.

• Estate/Gift Tax. Interest in a land trust, unlike other forms of trust is held in shares similar to a corporation. If an individual owner dies holding an interest of shares in a land trust he or she will be subject to estate similarly to if they owned the property individually. However, this can be avoided, if advance steps are taken to transfer this interest prior to death.

  Despite the fact the real property which owns the land trust is located in the State of Florida, because the interest in the land trust is distributed in shares, the situs (legal location) of the shares is stated within the land trust to be where the beneficiaries reside. Absent any indication to the contrary, any shares transferred among beneficiaries shall be deemed to have occurred in Canada where the beneficiaries reside and shall be exempt and not subject to U.S. Gift Tax as a transfer of intangible property in accordance with I.R.C. 2501(A)(2).

  As a result, shares of a land trust in the real estate may be transferred outside of the country at any time prior to an owner/beneficiary’s death and avoid estate tax. The transferee who receives this interest taxes over the basis in the property and will eventually be the party who pays capital gain at the individual rate. Since the beneficiaries of a land trust are not required to be disclosed until the time of sale, great flexibility of reporting the ownership interest exists.

CONS:

• Income Tax. As demonstrated above the best way to own property for income tax purposes is through individual ownership which provides the lowest income tax consequences. Fortunately, a land trust entitles the owner/beneficiaries to receive individual taxation treatment. When creating this trust it is important to reference I.R.C. 674-677 which provides that the beneficiares of the trust shall be treated as the owner for tax reporting purposes.

• Capital Gain. As a result of individual tax treatment, the owner(s) of a land trust receive the favorable rate of capital gain (presently 20%).

• Double Taxation. Pursuant to Section 1.671-3(2)(1) of the Internal Revenue Code no additional separate Tax I.D. is needed for the trust. As a result under the vast majority of tax treaties, upon sale, similar to an irrevocable trust the seller (owner) of the trust will be able to receive credit for any capital gain tax paid in the U.S.

• Probate, similar to an irrevocable trust is totally avoided through the use of a land trust. Even though the owner/beneficiary may pass away the title remains in the trust and there is nothing the probate court needs to do to transfer title to beneficiaries. The trust already provides for subsequent beneficiaries similar to a beneficiary designations found within a life insurance policy.

• Guardianship, similar to an irrevocable trust provide for the trustee to sign any necessary documents, including deeds of conveyance. If one trustee is incapacitated, a successor trustee may act avoiding the need for a guardianship.

• Estate/Gift Tax. Interest in a land trust, unlike other forms of trust is held in shares similar to a corporation. If an individual owner dies holding an interest of shares in a land trust he or she will be subject to estate similarly to if they owned the property individually. However, this can be avoided, if advance steps are taken to transfer this interest prior to death.

  Despite the fact the real property which owns the land trust is located in the State of Florida, because the interest in the land trust is distributed in shares, the situs (legal location) of the shares is stated within the land trust to be where the beneficiaries reside. Absent any indication to the contrary, any shares transferred among beneficiaries shall be deemed to have occurred in Canada where the beneficiaries reside and shall be exempt and not subject to U.S. Gift Tax as a transfer of intangible property in accordance with I.R.C. 2501(A)(2).

  As a result, shares of a land trust in the real estate may be transferred outside of the country at any time prior to an owner/beneficiary’s death and avoid estate tax. The transferee who receives this interest taxes over the basis in the property and will eventually be the party who pays capital gain at the individual rate. Since the beneficiaries of a land trust are not required to be disclosed until the time of sale, great flexibility of reporting the ownership interest exists.

• If a high net worth individual does not take steps to transfer his or her interest by transferring shares within the land trust to intended beneficiaries, in escrow prior to death estate tax can apply. Additionally, some insurance companies frown upon land trusts as they claim the beneficiaries (owners) may not always be easily identified.

TWO LESSOR USED STRATEGIES TO CONSIDER WHEN DEALING WITH FOREIGN BUYERS

MULTIPLE OWNERS

In an effort to enhance the $60,000.00 estate tax, exclusion, per individual, and increase the exemption of world wide assets for estate tax purposes, many times multiple family members may be added to the deed at the time of purchase. However, to avoid gift tax considerations, the funds must come from a bank account located outside the United States and cannot occur at a later date.

To avoid probate under the above scenario, ownership should be held as joint tenants with full rights of survivorship. As a matter of law, ownership interest will automatically pass to the survivors. However, one negative consequence is that, at the time of sale, all owners must be located and are required to sign off on the deed. There can be negative consequences of bringing additional family members into the picture by opening the door to third party claims (such as divorce or tax or judgment liens) which may unexpectedly arise.

ENHANCED LIFE ESTATE

Florida is one of a few states which permit an enhanced life estate. Under this scenario, at the time the deed of conveyance is drafted, the buyer may designate their beneficiaries upon death and avoid probate. At the same time the owner can also retain the power of sale and collect all proceeds should they elect to sell the property prior to their death.

At all times, the parties are taxed at the low income and capital gain rates. At first blush, this appears to be a simple solution, however by retaining rights over the property (including the power of sale) the I.R.S. will apply Sections 2036 and 2038 of the Internal Revenue code and include the interest of the decedent for U.S. estate tax purposes. As a result, this will never work for high net worth individuals as the onerous estate tax concerns will not be avoided.