The United States is known for having an open economy, which essentially means that the domestic community is able to engage in investing and trade with most foreign countries. Individuals and businesses in other countries can also choose to trade and invest with entities in the U.S. While most entities and individuals who invest in U.S. real estate are located in the same country, there are numerous reasons why a foreigner might want to invest in U.S. real estate as well.
The total combined value of all residential homes in the country comes in at around $33.6 trillion. To understand just how large this value is, it’s greater than the total 2020 GDP for the U.S., which is around $19.39 trillion. As this country has one of the more sizable economies in the world, the higher value of residential homes says a lot. The short answer to this question is that foreigners can invest in real estate throughout the U.S. However, there are numerous things to consider if you wish to do so. This article details what you need to know about investing in U.S. real estate.
Difficulties That Foreign Investors May Face When Purchasing U.S. Real Estate
While it’s relatively easy for foreign investors to purchase and invest in U.S. real estate, there are some difficulties that any foreign investor must overcome if they want the process to be smooth and straightforward. Even though it’s perfectly legal for foreigners to invest in U.S. real estate, it may be difficult to obtain a loan for the investment.
It’s also common for foreign investors to run into difficulties understanding U.S. taxes, which can lead to substantial problems when it comes time to invest in a property. Foreign investors will generally have a more difficult time investing in real estate as compared to U.S. citizens. With this in mind, let’s talk about all of the drawbacks and hurdles that you will face as a foreign buyer of U.S. real estate.
Obtaining Real Estate Loans As a Foreign Investor
Likely the main issue that foreigners face when attempting to invest in U.S. real estate is that it can be difficult to obtain a loan from a bank or other financial institution. When it comes to residential properties, both Freddie Mac and Fannie Mae are government-sponsored corporations that guarantee most home loans. The standards that are set by these two institutions are followed by the majority of banks and other financial institutions. The problem is that neither Freddie Mac or Fannie Mae will purchase loans from individuals who aren’t U.S. citizens. Instead, you’ll need to find lenders that don’t work with Freddie Mac or Fannie Mae.
The majority of banks will also forego providing loans to individuals who have never paid taxes within the U.S. This reduces the number of financial institutions that could provide you with the necessary loan. To counteract this issue, you’ll likely need to perform extensive research to find financial institutions that will lend to foreign investors. Keep in mind that you’ll need to provide proof of strong financials. Most foreigners likely don’t have a credit score, which is a top consideration among most banks when they are deciding whether or not to lend money to someone. If you don’t have permanent ties to the U.S., you’ll likely find it difficult to get the loan you’re looking for.
Another reason that banks are wary of lending to foreign individuals is that it’s nearly impossible for the lender to take a foreign borrower to court if the borrower defaults on the loan. While you could try to obtain a loan in your own country, many foreign lenders will avoid providing a loan in this situation. Banks don’t like to provide borrowers with loans outside of their home country. There are also many countries where the laws and regulations dictate that loans can’t be provided outside of the country.
When you’re searching for the right lender in the U.S., it’s important that you’re aware of the costs that come with getting a loan, which typically includes:
- An Appraisal fee
- An Origination fee
- Prepaid interest fees
- Closing fees
- Insurance fees
These costs could be higher for you than for U.S. borrowers because banks view foreign investors as being riskier to lend to. In order to offset some of this risk, lenders will usually charge relatively high-interest rates or require a substantial down payment before providing you with a loan. The approval process for the loan could also be more stringent, which you should prepare for. If you were a U.S. citizen, the approval process would likely involve the bank looking at your total expenses, your income, and your entire credit history in order to ascertain if you are wholly qualified for the loan.
As a foreign investor, it’s much more difficult for the banks to verify these aspects of your finances. You’ll need to provide much more documentation than is normal, which can include your bank statements and yearly tax returns. Because of the larger amount of documentation that needs to be provided, the approval process will likely also take longer to process.
Navigating Taxes As a Foreign Investor
The U.S. requires foreigners to pay a certain amount of taxes in the country on any real estate gains. You might also be required to pay these taxes in your own country depending on local laws. If you are considered to be a non-resident alien, you won’t need to file your tax return in the U.S. unless you’re currently employed in the country or have source income from the U.S. In accordance with this term, source income includes income that you earn from renting real estate that’s located in the country.
It’s also important to understand that any owner of real estate in the U.S. is subject to the estate tax. This particular tax is paid once the owner of a property dies. The total amount of the estate tax can be as much as 40 percent of the property value. The exact amount that you pay depends on what the estate is currently valued at.
US Real Estate Holding Structures Foreign Investors Should Consider
There are a variety of holding structures that foreign investors are able to use if they would like to avoid paying certain taxes on the real estate that they invest in. Keep in mind that the exact structure type that you select should align with your investment goals if you want to make the most out of this investment.
Individual Direct Ownership
This type of holding structure allows for a foreign investor to own real estate in the U.S. in their own name. This is a very simple type of ownership that’s considered to be beneficial if you want to keep costs down. The main issue with individual direct ownership is that the long-term benefits are minor and could open you up to liability, estate taxes, and various tax reporting requirements. If your property is ever rented out, you will be tasked with paying income tax. If damages occur on the property, you will be held liable for any repair expenses.
Forms of Corporate Indirect Ownership
As mentioned previously, corporations are fully exempt from paying the U.S. estate tax, which is why it’s highly recommended that you place your real estate investment into some kind of corporation holding structure. Here are examples of different corporations that can help protect foreign investors from taxes and liabilities.
Foreign Investors Can Create an LLC
You could choose to create a limited liability company (LLC) to hold your investment. This type of corporation allows for the lowest amount of income taxes when compared to other types of corporate indirect ownership. There is also limited liability for your wealth as an investor, which is directly limited to the value of your property.
You’re not held responsible for any of the damages that occur since your property and the assets within are protected under an LLC. The privacy of the property will remain fully intact since you won’t need to register the name with the state. The main issue with creating an LLC is that it will still be subject to the estate tax. The income tax and sales tax consequences for the property are the same as if you owned the property directly.
U.S. Blocker Structure
This structure is appealing for individual investors who would like to avoid the estate tax that typically occurs upon death. You will have both privacy and asset protection if you decide to use a U.S. blocker structure. If the corporation that you create with this structure is willing to wait for a required five-year period following the sale of your property, you can distribute the cash that was collected from the sale to yourself without any tax consequences. However, the corporation will be subject to a very high capital gains tax rate when the property is eventually sold. .
This is a complex holding structure that you can use with your U.S. real estate investment. It’s very similar to the U.S. blocker structure with some key differences. This type of holding structure is solely recommended if you’re going to be making larger investments in real estate throughout the U.S. In general, this structure is used when the investments involve several different investors or a type of fund.
In order for this structure to be successful, a substantial amount of planning will need to be done. For one, the investor will need to also have a U.S. corporation. Part of the investment must be loaned to the U.S. corporation, which allows the corporation to obtain certain tax deductions. Since the corporation is able to deduct the interest, the effective tax rate is also lowered.
Ready to invest in U.S. Real Estate?
If you’re interested in investing in U.S. real estate but don’t classify as a citizen of the country, you can still invest as long as you’re aware of what this process involves. The primary difficulties that you’ll face when attempting to invest in U.S. real estate include finding the right loan and being approved for the loan once you’ve found it. You may also be required to make a down payment of 30 percent or more.
While foreign investors will encounter numerous hurdles when investing in U.S. real estate, the benefits of making these investments can be fantastic and may allow you to obtain high returns on your initial investment. To lower your expenses, consider creating some kind of holding structure to place the investment in. With these guidelines, you should be able to get started with your U.S. real estate investment.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.