The U.S. has some of the most affordable real estate in the world, as pointed out in my earlier posts. Rental yield or rent versus price is also higher than in most other countries. This is because of the real estate crash that started after 2007 and ended in 2008.
Foreigners (i.e., who do not have a green card or U.S. citizenship) have an interest in U.S. real estate due to political stability, low prices, higher rental yield than other countries, and other reasons. What holds them back is typically lack of financing and concern about tax issues.
Before the financial crisis, there were some companies like Countrywide that would lend to foreigners. 99% of loans are Fannie or Freddie loans and the current rules do not provide for financing for foreigners.
However, all is not lost. Some sellers provide seller financing. This is relatively unusual for single family homes, but not impossible. On my MLS and probably most others, it is possible to search for listings for which seller financing is available. It is typically offered when a property is difficult to sell, such as in the case of vacant land or if the property is overpriced. Seller financing is a bit more common with multifamily properties such as those with more than 4 units.
For properties with more than 4 units, conventional (Fannie Mae, Freddie Mac) financing is not possible. For those, you need commercial financing. Commercial financing is much more flexible in terms of rules and underwriting requirements. There are commercial lenders who specifically advertise that they lend to foreigners. With commercial loans, the lenders tend to place more emphasis on the strength of the property than on typical formulas. A highly cash flowing multifamily property is typically not too hard to finance with commercial financing.
It is also possible to buy a property “subject to” the existing loan. Sellers are more likely to agree to this when they are distressed or owe more than their properties are worth. The existing loan is left in place in the seller’s name. There is much risk to doing this in that Fannie Mae and Freddie Mac (conventional) loans include “due on sale” clauses that allow the bank to accelerate the loan when there is a sale. When you buy “subject to,” you are taking on this risk that the loan may be called at any time. The lender may find out about the sale if there is a change in the named insured. It is possible to have multiple named insureds on an insurance policy. The lenders do not always accelerate loans when there is a “subject to” transaction, but they may choose to do so if interest rates start rising. If interest rates rise above the interest rate of their loan, they may choose to call it due so they can sell a higher interest loan. Also, the seller may eventually realize that this loan is on his or her credit report and impedes the ability to obtain a new loan. They may decide to inform their lender of the sale to try to get the loan off of their credit. This will trigger a due-on-sale problem and the buyer will have to come up with funds or other financing or sell the property.
Of course, commercial loans can also be used for single family homes. The disadvantage of commercial loans is that they typically have worse terms than conventional loans. Term is usually 15 years maximum, after which rates will adjust. Also, starting rates are typically the same as or higher than 30 year fixed loans.
In any event, financing is possible for foreign investors.
With regard to U.S. income taxes, rent from a U.S. property is subject to U.S. income taxes. A property manager is required to withhold a flat 30% of gross rent received from passive rental income. However, this withholding can be avoided by filing a form requesting to be taxed as a local and obtaining a social security number.
The method by which rental income will be taxed depends on whether or not the foreign person who owns the property is considered “engaged in a U.S. trade or business.” Ownership of real property is not considered a U.S. trade or business if it consists of merely passive activity. Such passive rental income is subject to a flat 30 percent withholding tax (unless reduced by an applicable income tax treaty) applied to the gross income rather than the “net rent” received.
If, on the other hand, the foreign investor is engaged in a U.S. trade or business such as the developing, managing and operating a major shopping center, the rental income will not be subject to withholding and will be taxed at ordinary progressive rates.
Foreign individuals and foreign corporations may elect to have their passive rental income taxed as if it were effectively connected with the U.S. trade or business. Once such an election is made by attaching a declaration to a timely filed income tax return, there is no obligation to withhold even in a net-lease situation. Expenses such as mortgage interest, real property taxes, maintenance, repairs and depreciation (accelerated cost recovery) may then be deducted in determining net taxable income. These expenses can be deducted if an income tax return Form 1040NR for nonresident alien individuals is timely filed by the foreign investor. Once made, the election may not be revoked without the consent of the IRS.
The U.S. allows almost any expense to be deducted including interest. In addition, a depreciation deduction exists for a fictional loss in value of the building. After this depreciation deduction, even a positive cash flow property can end up without any U.S. tax obligation. This tends to particularly be true when there is financing in place. Thus, the U.S. tax issues are also surmountable.
The foreign investor should thus be more concerned with tax issues in his or her own country. This may effect how title is held in the U.S. For example, it is possible to hold title in a limited liability company that provides liability protection but that is disregarded for U.S. tax purposes. Holding in a U.S. limited liability company, however, causes problems with respect to Canadian income tax if the owner is a Canadian. Thus, it is important to speak to a local tax adviser, hopefully one who also understands tax treaties and U.S. taxes, about tax issues before buying in the U.S.
Foreigners can open bank accounts in the U.S. if they are physically present, obtain an EIN (tax ID number), and have an address. Buying real estate provides an address, of course. Latino credit unions have experience opening bank accounts for non-citizens.
