01 Aug New Opportunities for Investment Structures in US Real Estate (Part 2)
In my previous blog post, I explored the three classic ways for non-US taxpayers to structure their investments in U.S. real estate, and the main advantages and disadvantages of each.
These three ways are as an individual, as a corporation and through a trust. Now I would like to focus on exploring three opportunities to lower your overall tax rates on your investments within these structures that were created by the new Tax Cuts and Jobs Act (Trump tax reform).
Corporate tax rates
The tax reform lowered corporate tax rates from a maximum of 35 percent to a fixed rate of 21%. This significant reduction makes this option more attractive for investors, especially given the other advantages of investing through a foreign corporation – namely estate tax protection and anonymity which were discussed in my previous blog.
Additionally, regarding branch profits tax, if you close the corporation or cease its U.S. activity in the year of the final gain, you can also avoid branch profits tax (this requires close work with a U.S. tax professional). This change contributes to a U.S. corporate tax rate that is very similar to the rate paid by the corporation in Israel and makes this option much more attractive.
The second opportunity is the change in earning stripping rules. The earning stripping rules require a certain debt-equity ratio in order to claim that certain money was given as a loan and therefore interest expenses can be claimed (and not as an equity investment) by the borrower.
In the past, the ratio needed was a 3-1 debt-equity ratio. The reform does away with this limitation, provided that your income is below certain thresholds. This allows taxpayers to consider structuring their investment more as a loan than as an equity investment, thus creating a greater interest expense for the company and lowering the company’s taxable income.
Additionally, the income earned from this loan would be interest income for the taxpayer and therefore it could qualify for the portfolio interest exemption for U.S. tax (if it meets certain conditions) and would be subject to a tax rate of 25% in Israel (this could be tax-exempt in Israel for immigrants in their 10-year tax holiday).
The third opportunity is based on the new Section 199A rules. These rules provide that certain pass-through entities, such as LLCs or partnerships, receive a non-cash deduction of 20% on certain income.
There are income limitations and other limitations to this new section (please consult your tax advisor). However, if used properly this tax deduction can significantly lower your effective tax.
Additionally, since this applies to pass-through entities the underlying taxpayer using this deduction will be the individual owner/partner of the pass-through who already has lower tax rates on capital gains. While this is a complicated section of the new tax code, if used properly it can create an opportunity for a lower tax rate on the income from the investment.
These are just a few of the opportunities created by the tax reform. We would be happy to work with you on a personal basis to find the best structure for you.
The writer is a partner at Philip Stein & Associates and head of the Individual and Partnership Tax Department