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Derren Joseph is a Partner at Advanced American Tax, part of an international tax team that works with 6, 7, and 8-figure international entrepreneurs and expats to legally minimize their global tax burden and protect their wealth. Derren runs a small tax team out of Singapore that's part of a larger organization, Moores Rowland Pacific Tax Consultants.
Today we discuss international tax and asset protection implications of investing in foreign real estate, the challenges of investing in foreign real estate, why the United States is highly sought after by foreign investors, and much more.
Rules for US Expats
Form 2555 is where the foreign income is declared separately, and foreign tax credits can be offset against US tax liability. Due to the Financial Tax and Compliance Act (FATCA), there's now enhanced information disclosure for foreign investing, which is Form 8938. This is similar to the information on an FBAR, a foreign bank account report. Every US exposed person must declare foreign bank accounts and financial accounts of any nature.
Derren rarely encounters US citizens hunting internationally for deals because the yields in the US are generally higher than the rest of the world. Instead, these situations are generally more opportunistic in nature, where an individual may hear about or otherwise be exposed to a deal and decide to participate because of an opportunity for growth.
"If I were to try and gauge market size, I would say there's a greater appetite for foreigners investing into the US than there is for US exposed persons investing outside of the US."
For the most part, from a US tax perspective, there are not large differences. If the property is held in some legal structure, the business deductions still apply. Revenue can be extracted as dividends, and capital gains generally still apply upon exit.
One thing that is a bit different is control. For the most part, foreign investors can invest into anything in the US. This doesn't apply for US individuals investing globally due to the foreign ownership rules of other countries.
Derren has seen many issues arise when real estate groups, syndicates, and gurus travel globally to spread the word of an easy path to wealth once foreigners enter the US markets. The yields may be pretty good, but other claims are often exaggerated and the advertised investment process is actually sloppy.
Almost always, it's significantly more expensive, time-consuming, and painful to fix previous errors rather than execute properly the first time.
These areas include factors such as the proper use of escrow, the use of LLCs, and relevant tax considerations such as estate taxes.
"From my perspective, coming from the Western mindset, doing business in the US is much easier and the yields are better, generally speaking. In pockets, in other international markets, sometimes the yields are good or sometimes it's the growth - the opportunity for capital gains in emerging markets. It's more of a growth game rather than sitting back and collecting rental income."
"In my limited, humble opinion, [international tax] is a constant cat-and-mouse game. There are high-priced lawyers who look for opportunities. When they find it, they exploit it on behalf of their clients. Then, the jurisdictions realize what's going on, and they pass legislation to plug the hole."
For most investors on the lower end (six-figures), an LLC is generally recommended, one per property. That LLC would be held by an offshore company or maybe a trust, such as a Singapore Qualified Trust, Singapore Private Limited Company, or other structure on top of an entity in Nevada or Wyoming, for example. The trust brings privacy and protection.
Investors may also consider a structure for tax benefits, and this varies widely. Some countries, such as Singapore and Malaysia, don't have tax treaties with the US. However, countries such as the Philippines, Indonesia, Japan, and Australia do have tax treaties with the US. For example, even though an LLC may be the default, investors may choose a C Corp for the reduced tax rates on qualified dividends. Additionally, using an offshore company can help legally avoid US estate taxes.
Derren hasn't frequently dealt with the situation of active vs. material participation for US outbound investors because the best practice is to avoid doing foreign business in your own name, so there is not conversation about passive losses and passive activity rules. Generally speaking, a corporate structure is used. The conversation is then about carrying forward losses.
The nature and participating countries of a foreign investment varies so widely that it's impossible to paint with a broad brush, each situation must be analyzed individually.
Funds, or income, can't simply be rerouted through a country purely to take advantage of their legislation or treaty status - there must be a business reason for using a certain jurisdiction, not solely for the tax benefit.
"Whether you think of it as geopolitics or the tax code, an incentive was created for offshoring. Now, a lot of the discussion and rhetoric has been around manufacturing. For example, Detroit, had a lot of great manufacturing jobs and those are gone. First to Mexico, and now to Asia and China in particular. Perhaps a lesser story, in terms of visibility, has been services."
Effectively Connected Income and the FDAP Withholding Tax
If income isn't considered effectively connected, then the FDAP 30% withholding comes in to play. To Derren, this only occurs without seeking the proper counsel prior to the deal. Even with just an LLC, treated as a passthrough, an election can be made to treat the income as effectively connected income from day 1.
Generally speaking, business will be done through an LLC. The LLC will be held by a trust or other offshore company and the income will be treated as effectively connected.
Puerto Rico and Expat Benefits
To take advantage of the tax benefits that come with Puerto Rico, the individual must live there for at least 183 days (6 months) and sever most ties with their US business, including US banking relationships and their primary residence. Individuals must truly move there and fully live in Puerto Rico.
The tax benefits include massively reduced tax rates for passive and earned income.
In general, just by moving out of the US, individuals benefit from the foreign earned income exclusion. Depending on the location, this could be $150K-$160K that's sheltered from US tax with the Section 911 Foreign Income Exclusion.
"There are benefits to just living and doing business internationally, being an international entrepreneur, an expat. We see that arbitrage going on right now with the California exodus to states like Texas, or New York to Florida. It's just taking that arbitrage to the next level."
Learn more about Derren and his work: htj.tax
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