The US Is About to Become an Even Bigger Tax Haven
It’s often not “PC” (politically correct) to point out the truth. But someone needs to do it.
Here’s an “inconvenient truth” for President Obama and those in Congress who want to shut down what they call “offshore tax havens.” It’s this: The US is by far the world’s largest tax haven.
As long as you’re a foreign investor, that is. US citizens and residents can’t take advantage of these incentives.
As my mentor, Marshall Langer, often says, no one is surprised when you tell them that the world’s single largest tax haven is an island. But they are often shocked when you tell them the name of the island is Manhattan.
But Manhattan offers only the same tax advantages the entire US offers foreign investors. Now Congress wants to sweeten the deal. A bipartisan proposal to expand America’s tax haven status will make it easier for foreigners to make tax-free real estate investments in the US.
More about that in a moment. But first, let’s review why the US is a tax haven:
Most capital gains in the US are tax free for foreign investors. That includes virtually all gains except those associated with US real estate or a US trade or business. In contrast, US citizens and residents pay tax on most long-term capital gains at a top rate of 20%. For gold, silver, and other “collectibles,” the top rate is 28%.
Interest payments from US banks and Savings & Loans to foreign investors are tax free. Today, foreigners hold perhaps $1 trillion in US banks. Even though their accounts aren’t taxable, deposits up to $250,000 are insured by the Federal Deposit Insurance Corporation (FDIC). Foreign investors also pay no tax on interest payments from US Treasury obligations and many corporate bonds. In contrast, US taxpayers pay tax on interest payments at a top federal rate of 39.6%, plus the 3.8% Obamacare tax on high earners, plus state income tax at rates as high as 13.3% (in California).
The IRS doesn’t share information with other countries on foreigners investing in the US. Laws like the Foreign Account Tax Compliance Act (FATCA) force foreign financial institutions to send information on US account-holders to the IRS. But there’s no legal mechanism for the IRS to reciprocate. Indeed, the IRS can’t send investment data to a foreign country’s tax authority unless that country has either a tax treaty or a tax information exchange agreement (TIEA) with the US. Even then, the IRS can’t provide information unless its foreign counterpart asks for it and tells the IRS where to look.
Most Americans would be shocked if they knew that the US is – by far – the world’s largest tax haven. But that’s not enough for Congress. It’s poised to open the floodgates even wider for foreigners to make tax-free real estate investments in the US.
Back in 1980, Congress created an exception in the rules that impose no tax on the capital gains of foreigners investing in the US. The Foreign Investment in Real Property Tax Act (FIRPTA) imposes capital gains tax on profits from the sale of foreign-owned US real estate. When a foreign investor sells US real estate, the seller must withhold 10% of the gross purchase amount. The seller must then deposit those funds with the IRS as an advance payment on the tax ultimately owed by the foreign investor. The foreign investor must then file a tax return with the IRS, calculate the tax due, and pay the difference (or receive a refund).
Naturally, since we’re dealing with the US Tax Code, there are exceptions. And an exception big enough to drive a truck exists for real estate investment trusts, or REITs. If capital gains in the REIT are recharacterized as dividends, foreign investors who invest in US REITs aren’t subject to FIRPTA. And as a result, they pay no capital gains tax.
However, the REIT exemption applies only to foreign investors who own 5% or less of the entity. In addition, a REIT must have at least 100 shareholders. One reason Congress imposed these limitations was to prevent individuals or small groups of foreign investors from creating their own REITs, thus bypassing FIRPTA.
In real estate circles, FIRPTA is deeply unpopular. So is the 5% or less requirement for gains in REITs to be free of tax consequences for foreign investors. However, wealthy US real estate interests have plenty of money to wine and dine members of Congress and pad campaign war chests. So it’s hardly a surprise that a bipartisan consensus has emerged on the need to “reform” these rules.
The Real Estate Investment and Jobs Act of 2015 would double the 5% threshold to 10% in publicly traded REITs. What’s more, “qualified” foreign investors who own a greater than 10% share of a properly configured REIT could continue to receive the bulk of their gains tax free. To make the proposal “revenue neutral,” the bill would increase the withholding tax on property sales not exempt from FIRPTA to 15%.
Let’s summarize. Congress is seriously considering a bill that would make it easier for wealthy and powerful foreign interests to invest in US real estate without paying tax on the gains. At the same time, smaller foreign investors, e.g., persons simply purchasing a vacation home in the US, would be subject to higher withholding taxes under FIRPTA.
The US is already the world’s largest and most sophisticated tax haven. It’s also leading the charge against other countries offering the same advantages, with laws like FATCA. But it’s never enough… Congress wants even more untaxed money to flow into US real estate.
Keep that in mind next time you hear someone grumbling about “untaxed investments” in “offshore tax havens.”
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