TAXES FOR INVESTMENTS IN THE U.S.
With a global economy and a relatively strong Euro, it is still very appealing for Italians to invest in the United States. This investment can take the form of purchasing a rental apartment in South Beach to setting up a gelateria in New York City. However, when a foreigner invests in the United States there are five major taxes to keep in mind: i) Firpta, ii) Income tax, iii) Capital gains, iv) Sales tax and v) Transfer taxes (estate tax, gift tax and generation skipping transfer tax).
The purpose of this article is to provide you with a brief overview of each tax and what issues you need to be on the lookout for as a foreign investor from Italy. It will also provide you with some tax planning tips for your U.S. located investment. The best part about tax planning in the United States is that when done properly you can minimize the tax liability generated by your United States investment.
As a general rule when a foreigner sells real estate located in the United States the buyer is required to withhold fifteen percent (15%) of the purchase price and remit that money to the Internal Revenue Service (IRS) as estimated tax payment. For instance, if you bought an apartment in New York City in 2021 for USD 800,000 and sell it two years later for USD 1,000,000 the buyer would be required to withhold USD 150,000 even though the taxes would most likely be around USD 40,000. That is an additional USD 110,000 that would be withhold because of lack of proper tax planning. Also please keep in mind that this mandatory withholding is required even if the real property is sold at a loss. In that case you will be receiving even less at the closing.
Once the estimated tax payment is remitted to the IRS the foreign seller is required to submit a United States tax return on the following year. In the tax return the actual tax liability (i.e. how much is actually owed in taxes from the sale of the real property) is calculated and a request for a refund is submitted. Nine out ten times a refund is requested. Usually the amount withheld by the buyer (the 15 percent) is higher than the actual tax owed.
However with proper tax planning this mandatory withholding can be avoided. A couple of ways in which this can be done is by either requesting a withholding certificate before the actual sale date or owning the US real property in a tax efficient structure such as a United States business entity. The concept that may best work for you depends on your particular situation and has to be custom tailored to you.
Whenever you are conducting business in the United States, whether it is active (as in the case of a gelateria) or passive (as in the case of the rental of an apartment), you have to pay income taxes of the net profit generated by the business venture.
While most foreign investors know that they have to pay income taxes on the income generated by an active business, they do not always know that they have to pay taxes on the income generated by their passive business (i.e. the apartment rented in south beach) as well. Even if you rent the U.S. located apartment for one month you may still be required to report this income. However, because of different deductions available to property owners, rarely would you actually have to pay taxes on the income generated by the rental income.
While it is true that both the United States and Italy will tax the income generated by United States business venture; this does not necessarily mean that you will be paying double taxes on the same profit. The United States and Italy have entered into a tax treaty that addresses this issue. Under the income tax treaty between the United States and Italy, the Italian investor would receive credit in Italy for any taxes paid to the United States on the income generated by U.S. business investments.
As a general rule, when you sell a capital asset you will pay taxes on the gain generated by the sale. The gain is equal to the sales price (what you are selling the asset for) minus the basis of the capital asset (this is usually the cost of the asset). If you owned the asset for more than a year, then you generally are taxed on the gain at the prefer capital gain rates. If you owned the asset for less than a year you are tax on the gain at the regular income tax rates.
A typical example of a capital gain transaction is the sale of an apartment. Let's say you purchase an apartment in South Beach in 2021 for USD 500,000 and you made no improvement to the apartment. You then sell the apartment in 2022 for $650,000. Since you owned the apartment for more than one year you will pay taxes at the prefer capital rates. The amount of the gain is USD 150,000 which is the sales prices (USD650,000) minus the cost of the apartment (USD500,000).
While most of the taxes discussed in this article are enforced at the national level, there is a local tax worth mentioning, the sales tax. Sales tax is a tax imposed by the local government at the point of sale on retail goods and services. The actual percentage of the tax rate and which items and/or services are subject to sales tax varies from state to state and county to county.
Unlike income tax, sales tax is paid by the end user (i.e., the ultimate buyer) and not the seller. However, you as the seller are required to collect and remit this tax to the local authority. For instance, you open a store in Los Angeles where you will be selling clothes imported from Milan. You would be required to collect the sales tax on the purchases made by your clients and remit those funds to the State of California Department of Revenue. This tax is in addition to the income tax you have to pay for the profit you made on the sale.
Another group of taxes that you have to keep in mind when investing in the United States are the transfer taxes. As opposed to income tax, these group of taxes are imposed when you transfer United States situs property for free, such as in the event of an inheritance or a gift. There are three taxes that fall under this category. They are estate tax, gift tax and generation skipping transfer tax.
The estate tax is a tax imposed on the transfer of United States situs property at death such as when you bequeath property. When a foreigner transfers United States situs property at his or her death there is a tax imposed on this transfer. The first USD 60,000 is exempt from taxation (i.e. is transfer taxed-free) and the rest is taxed at a progressive tax rate with the highest rate being 40 percent.
However, Italy is one of the few countries that has an estate tax treaty with the United States which makes this a de minimis tax. Nevertheless, it is important to know what constitutes a United States situs property so you can tell your tax attorney and ensure that no additional tax planning is needed.
For estate tax purposes the following items are considered US situs property:
· Real property located in the United States;
· Tangible personal property located in the United States (such as cash, jewelry, artwork and automobiles);
· Ownership interest in U.S. companies, such as corporations and certain partnerships and limited liability companies; and
· Ownership interest is life insurance policies on the life of another person.
The gift tax is a tax imposed on transfer of United States situs property during life for less than fair market value. Please keep in mind that companies cannot make gifts therefore this tax is mostly applicable to persons and not corporations, trusts, partnerships, etc.
Unlike with the estate tax, Italy does not have a gift tax treaty with the United States, thus you have to be very careful when transferring a United States situs property for less than fair market value. Also unlike the estate tax the exemption amount is only USD14,000 per year per person.
For purposes of gift tax the following items are considered US situs property:
· Real property located in the United States; and
· Tangible personal property located in the United States (such as cash, jewelry, artwork and automobiles).
In this case, if you owned a vacation home in Los Angeles valued at USD 500,000 and wanted to gift it to your daughter, then the gift tax on the transfer would be approximately USD 200,000. In such a scenario you would want to do some tax planning to determine a way to minimize the tax consequences, such as selling the apartment to your daughter or gifting only a portion of the apartment.
The generation skipping transfer tax is a tax imposed in addition to the gift or estate tax. It is imposed on transfers to a second and subsequent generation. These transfers are taxed at a flat rate of 40 percent and the asset being transfer is valued at fair market value for tax purposes.
In the above example, if instead of gifting the Los Angeles apartment to your daughter, you gift it to your grandson, then you would paid an additional 40 percent in taxes since the gift is being made to your grandson (and you are basically skipping a generation, hence the name). This would be on top of the 40 percent in gift taxes you would be paying as well.
INVESTING IN THE UNITED STATES
The United States is still a very attractive country for foreign investors. While tax planning cannot guarantee the soundness of the investment, it can guarantee the tax efficiency of it. The only think you need to do is be tax savvy and properly plan your investment and that would be one less item to worry about when investing in the United States.