Foreign Nationals & Expats
Houston Tax Attorney
Estate Tax Planning for Non-Residents Owning U.S. Real Estate
IRC § 2101 imposes a tax on the transfer of the taxable estate of a person who was not a U.S. nonresident alien (NRA) at the time of death.
The 2017 Tax Cuts and Jobs Act increased the basic exclusion amount for estates of U.S. residents and citizens, doubling it from $5.5 million to $11.2 million. However, the IRC sections relating to the taxation of estates of non-U.S. residents remained the same – the excluded amount remains at a paltry $60,000.
A common situation is where a foreign investor has purchased U.S. real property and owns the property directly. Upon death, the value of that real property would be included in the estate and subject to tax on its gross estate exceeding $60,000.
While there are planning opportunities for NRAs to purchase U.S. real estate to avoid estate tax (such as owning U.S. real estate through a foreign corporation), opportunities are limited when an NRA already owns real property that is held directly.
Estate tax for non-residents – generally
The U.S. estate tax filing requirements of a decedent’s estate are determined by whether, at death, the decedent was a U.S. citizen or resident for estate tax purposes. And if the decedent was not a U.S. citizen nor a U.S. resident, whether the decedent had U.S. situs property.
A non-citizen non-resident decedent will be subject to U.S. estate tax on U.S. situs assets. The executor of an estate of a non-citizen, non-resident decedent is required to file a Form 706-NA to report property located within the United States worth more than $60,000.
If the decedent owned property with a surviving spouse who is not a citizen of the United States, the value of that property must be reported in full on Form 706. Under IRC 2056(d)(1), the unlimited marital deduction is generally not available for property passing to a surviving spouse who is not a United States citizen. Under IRC 2056A, bequeathing property to a noncitizen surviving spouse through a qualified domestic trust (QDOT) allows an estate to receive a marital deduction. For the marital deduction to apply, property must be transferred to the QDOT prior to the death of the decedent. However, a QDOT merely defers the tax and upon the death of the surviving spouse, the U.S. situs assets will be subject to estate tax.
The rates applicable to estates of NRAs are the same as those that apply to U.S. citizens, at a maximum tax rate 40%.
U.S. situs property
The following are a non-exclusive list of assets treated as U.S. situs property:
- Real estate located in the U.S.
- Tangible personal property is deemed to be U.S. situs property if physically present in the United States on the date of death. There is an exception for works of art which are imported solely for public exhibition, on loan to a non-profit gallery or museum or on exhibition or en route to or from an exhibition.
- Stock of U.S. corporations (those located in the United States or organized under U.S. law) is considered property in the United States.
- Generally, debt obligations are property located in the United States if they are debts of a U.S. citizen or resident, a domestic partnership or corporation, a domestic estate or trust, the United States, a state or a political subdivision of a state or the District of Columbia.
- Deposits with a U.S. branch of a foreign corporation that is engaged in the commercial banking business are treated as property located in the United States.
When an NRA investor has already acquired U.S. property
Once a NRA directly owns a U.S. real property interest, there aren’t many great options to avoid estate tax, but there are options.
The following options lead to unintended tax consequences:
- Making a lifetime gift. There is no lifetime gift tax exemption for NRAs. An annual exclusion of $14,000 is available, which is never sufficient, subjecting the transfer to gift tax.
- Exchanging the interest in the real property for stock in a foreign corporation. Transfers of USRPIs for foreign corporation stock generally do not qualify for nonrecognition treatment, subjecting the transfer to U.S. income tax.
The following approaches are worth looking into:
- The NRA becomes a U.S. resident for estate tax purposes to take advantage of the $11.2 million exclusion ($22.4 million if married filing jointly). However, doing so will also expose the individual’s worldwide assets to U.S. estate tax and to tax on worldwide income.
- The NRA transfers the U.S. real property interest for a U.S. partnership interest. The exchange of an interest in a U.S. real property for an interest in a partnership will receive non-recognition treatment for the transfer. Partnership situs rules come with uncertainty as the IRS has not provided much guidance on whether partnership interests are considered U.S. situs. It is unclear whether the IRS would apply a look-through test, or possibly a combination of factors including where the partnership was organized, the domicile of the decedent, or the partnership’s place of management. Depending on the circumstances, it can be a reasonable argument by the decedent’s executors that the partnership interest is not U.S. situs property. The risk is that the IRS may disagree with the position in the event of an audit.
- A foreign corporation owned by the NRA encumbers the asset with nonrecourse debt, which would limit estate tax exposure to the net value above the amount of debt.
- Purchasing life insurance to cover the estimated estate tax liability.