US Investors in Foreign Real Estate Must Study Tax Challenges

Investing in foreign real estate exposes US investors to significant cross-border legal and tax complexities. Making and managing the investment requires a thorough understanding of local real estate laws and adherence to restoration requirements and property use restrictions—especially on government-incentivized bargain deals.

It also means navigating tax treaties to minimize double taxation between the US and foreign jurisdictions, along with ensuring compliance with US foreign asset reporting rules. Investors and business owners must structure their investments carefully to prevent liabilities from one investment carrying over to another. Working with experienced cross-border tax and investment professionals to ensure compliance at every step is critical to a seamless process.

Let’s look at a hypothetical example. Marco is a construction business owner and great-grandson of Italian immigrants who has no investments outside the US. He is enticed by the idea of purchasing a couple houses in the mountains of Sicily for 1 euro each. He plans to move permanently to Italy within the next five years and live in one of the houses while using the others as investment property.

This plan isn’t as simple or inexpensive as it seems. In addition to the myriad expenses involved, there are significant legal and tax ramifications, the most significant of which may not even be directly connected to the real estate itself.

The Italian and French governments have been encouraging foreign investments in real estate in rural areas for the last several years. Approximately 25 municipalities have been part of those program to date, including Emilia-Romagna, Abruzzo, and Campania. The programs are especially attractive to first-generation wealth builders because such individuals don’t already have a real estate portfolio or significant assets to fully retire.

Following the example above, let’s say Marco has a net worth of over $35 million, but most of his wealth is in his construction business. He is still focused on reinvestment and growth and has little liquidity.

While the 1 euro houses were good advertising, Marco eventually purchases one in Mussomeli for approximately 12,000 euros ($13,000). Similar investment opportunities introduced in France are fraught with similar risks.

For US investors who seek to reestablish residency abroad or invest in foreign assets for the first time, several income and estate tax planning considerations come into play. Marco assumed some nominal costs for property acquisition and planned to complete the renovations himself, given his expertise in construction.

The municipality allowed for renovations on this project to be completed within three years. Marco had to guarantee his commitment to renovation with a deposit of 5,000 euros and had to plan to have his local business handled such that he could afford—in money and time—multiple trips to Italy to handle the renovations.

Marco operated a single-member LLC for decades without realizing the value of his business and has limited liquid assets. However, the foreign investment that seems nominal at first glance opens the floodgates to foreign bank and financial accounts reporting.

Foreign bank accounts to manage return on investments in the property including rental income may necessitate filing a Report of Foreign Bank and Financial Accounts and FinCen Form 114 under the Bank Secrecy Act, which requires reporting certain accounts held abroad by US citizens and residents subject to thresholds (such as an aggregate value of $10,000 any time during the year).

Foreign real estate holdings are also subject to the Statement of Specified Foreign Assets, Form 8938 reporting. A proper understanding of restrictions, requirements, thresholds, and compliance details is essential to prevent significant penalties for reporting errors and failures.

Back to Marco. His plan to relocate to Italy requires considerations of the implications of Italian residency and possible US expatriation. If he decides to expatriate, he will need to plan for the covered expatriate rules. Because his business interest itself exceeds $2 million (the minimum threshold for covered expatriate rules to apply), significant tax planning involving transfers and potential sale of his business prior to expatriation would need to be considered.

Additionally, he will be subject to estate taxes if he dies a noncitizen and nonresident of the US, with his US business being worth more than $60,000. If he seeks to retain his US citizenship, but resides abroad while continuing his business in the US, the US-Italy tax treaty affords some benefits against double taxation—including a savings clause that allows the US to tax its citizens under its laws instead of Italy’s.

Cross-border income and estate tax planning can greatly benefit Marco in reducing the impact of the unpredictable renovation costs for the properties and ensuring that the increased value of his estate and foreign holdings don’t exacerbate the impact on estate and gift taxes.

Small-business owners can structure investments abroad to provide the benefit of foreign income exclusion and foreign asset protection strategies. For example, because Marco can do much of the work to renovate the property himself and plans to secure rental income from the investment, he can time the restoration project to offset some of the tax implications on the income from his business with costs of maintaining the property abroad.

To protect his business in the US and reduce tax liabilities created by business income and potential rental income from his investments in Italy, Marco would benefit from moving and reinvesting the income offshore.

Additionally, he must consider how his foreign assets are held to allow for smooth transfers and avoid cross-border probate mishaps. Trust and business succession laws vary among jurisdictions. Developing a comprehensive asset protection plan that protects individual and business assets while allowing for flexibility in tax residency and investments can be especially challenging.

The complex and layered strategies inherent in foreign asset protection and business succession planning are particular to each client. But any client considering a transaction involving foreign investment should consult with competent cross-border tax attorneys. This will ensure that the asset itself is protected from taxation in multiple jurisdictions and that the change in the nature of their asset ownership doesn’t create negative estate and income tax ramifications.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Priya Prakash Royal is managing attorney of Royal Law Firm, an international private client tax law firm representing multinationals and business owners with US and cross-border wealth preservation and asset protection.

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