In tax law, the word “foreigner” refers to people other than U.S. citizens, U.S. resident aliens (green card holders) and U.S. residents for tax purposes (foreigners who reside in the U.S. for 183 days or more each year). Taxes involving real estate investment include property tax, tax on rental income if leased, tax on capital gains (if any) upon sale, and transfer tax at the time of title transfers.
Property tax is levied upon all property owners by local governments at the county, city and town levels. Whether you are a U.S. citizen, a resident alien or a foreign resident, you will need to pay property tax each year. The amount of the property tax can be substantial. It is a major part of your total expenses on the property. Investors are advised to find out the amount of the property tax before making a purchase.
Income tax on rental income is paid by foreign investors on the rental income of their rental properties. There are two types of rental income taxes – business income tax and investment income tax. If a foreign investor does not actively participate in the rental business and property management other than collecting rents, the rent is considered investment income. Property management companies retained by a foreign investor must withhold 30% of the rental income (not rental profits) and make payment of estimated tax on behalf of the property owner. This is called the Gross Income Method. If the property manager fails to withhold and make payment of the estimated tax, the Internal Revenue Service (the “IRS”) can come after the property manager for taxes owed by the foreign investor as well as penalties and interest. The IRS can even bring legal action against the property manager. The Gross Income Method can impair a foreign investor’s cash flow. If the investor actively participates in the property management, then there is no need to withhold tax. The investor will just need to pay taxes on the net income after deducting all associated costs and expenses from the gross rental income. This is called the Net Income Method. A foreign investor must estimate profits and pay estimated tax on a quarterly basis, and at the end of the year files a tax return to report the actual gain or loss as well as pay additional tax owed or request a refund of overpayment. The IRS permits a foreign investor who earns only investment income to elect not to have tax withholding by filing Form W-8ECI.
Income tax on capital gains in levied on capital gains earned upon the sale of a real property. If a property was held for less than one year at the end of the sale, the 10% to 35% tax bracket will apply. If the property was held for more than 12 months, the long term capital gain tax rate of 15% will apply. To prevent foreign investors from tax evasion, the law requires that the buyer, when purchasing a property from a foreigner, must withhold 10% of the total sales proceeds and files Form 8828 with the IRS within 20 days of the closing. The buyer will then provide the foreign seller with a copy of the Form 8828 as proof of tax withholding. If the buyer fails to withhold the tax, the IRS will require the buyer to pay the tax owed by the seller and pay a penalty of up to $10,000. The buyer is exempt from the tax withholding obligation only if the property purchased was to be used as the buyer’s primary residence and the price was under $300,000. In the year following the sale, the foreigner seller must file Form 1040NR with the IRS, report the capital gains on the property transaction of the previous year and attach a copy of the Form 8828 as proof of tax withholding. If the tax withheld exceeds tax owed, the foreign investor will receive a refund of the overpayment. If the tax withheld was less than tax owed, the investor will pay additional tax. In addition to Federal income tax, most states impose a capital gain tax. However, Florida does not impose income tax. Most other states also impose a transfer tax at the time of real estate transactions. In Florida, this is called Doc. Stamps on Deed. The buyer pays 0.7% of the sales price for stamp tax. If the buyer takes out a mortgage for the purchase, he or she will need to pay additional 0.35% of the mortgage loan amount as doc. stamps on note.
For short term rental properties, the investor also needs to pay a sales and tourist development tax, which is 13% of the monthly rental income.
Disclaimer: We are not certified public accountants or tax attorneys. The above descriptions of various types of taxes are meant as brief guidelines for investors in Florida real properties. They should be not relied upon as tax advice for making investment decisions or for fulfilling tax responsibilities. Investors are advised to consult a tax professional for tax related matters and questions.
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