Income and Expense
Annual Wealth Tax
Gain on Disposition
Estate, Gift and Inheritance Taxes
How Does the Tax Treaty Affect You?
It is important for French investors in the U.S. to review their estate plans
in order to take advantage of the France-U.S. tax treaty.
Both France and the U.S.
impose income and succession taxes, the necessary ingredients for double
taxation of crossborder investment. In order to facilitate the significant
economic flows between the two countries, France and the U.S. have had tax treaties in
force for many years (income tax treaties since 1932 and succession tax
treaties since 1949). Proposed changes to the existing treaty, which include
enhanced benefits for French investors in U.S. real estate, are discussed
below. In general, a tax treaty is a written agreement between two countries
providing uniform bilateral tax rules intended to avoid double taxation. Tax treaty provisions override each
country’s own tax laws and may be invoked by the taxpayer if the treaty rule
provides a lesser tax than the domestic law of the taxing country.
tax rules applicable to foreign investors in U.S.
real estate are generally less favorable than those applicable to U.S.
citizens and residents. However,
certain French investors are entitled to special U.S. (and French) tax benefits
under the France-U.S. tax treaties.
This article focuses on some of the more common U.S. and French tax issues encountered by
French-resident individual investors in U.S. real estate.
Rental Income and
Under U.S. tax law, rental income derived from U.S.
real estate is subject to a 30% withholding tax imposed on gross rents
unreduced by expenses or losses.
However, U.S. law
provides foreign investors the option of timely filing U.S. tax returns and electing
“net basis” taxation at regular rates up to 35% (or alternative minimum tax
“AMT” rates up to 28%). Once the
election is made, it can only be changed with IRS consent, and the election
applies to all of the investor’s U.S. rental activities (the
favorable annual-election provision included in a prior version of the treaty
is no longer available). Allowable tax deductions include expenses related to
the rental activity and straight-line depreciation computed over 27.5 years
for residential real property and 39 years for commercial real property.
Under French tax law, a French resident’s overseas net
rental income is subject to graduated tax at rates up to 48.09% with only a
deduction from income, not a credit against French tax, for foreign country
income taxes paid. Under the treaty,
French tax law is overridden so that U.S. real estate rental income is
effectively exempt from French income tax. Under the “exemption with
progression rule” the exempt income is however taken into account in
determining the tax rate on other income.
Annual Wealth Tax
Unlike the U.S., France
imposes an annual wealth tax on resident individuals, or nonresidents owning
taxable property in France,
at progressive rates up to
1.80 percent of net worth
exceeding 750,000 Euros (about $US970,000). The
treaty provides a five-year exemption from wealth tax for U.S. real estate owned by a U.S. citizen who is not also a
Gain on Disposition
The income tax treaty does not override U.S. tax rules for gains derived from
disposition of U.S.
Gain on Disposition (continued)
interests. Thus, a French investor’s net U.S. real estate gain is subject to U.S.
taxation under the regular tax or AMT rules.
gains tax rate is limited to a maximum 15% for property held more than 12
months; however, gain attributable to prior depreciation is taxed at a
maximum rate of 25%.
Under French tax law, a French resident’s overseas inflation-adjusted real
estate gain is generally subject to tax at rates up to 16% with only a
deduction from income for foreign country income taxes paid. The treaty does not include the favorable
“exemption with progression rule” with respect to gains; however, it does
override French tax law by allowing a credit from French tax limited to the
lesser of the U.S.
or French tax.
Estate, Gift and
Under U.S. domestic tax law,
the value of U.S. assets of a nonresident decedent or donor not a U.S.
citizen is subject to tax at graduated rates up to 55% after exemption of
only $US60,000 whereas a decedent domiciled in the
U.S. is entitled to exclude $US2 million, increasing to $US3.5 million in
2009, then decreasing to $US1 million after 2010). Since the 1988 enactment
of a harsh U.S. tax law change effecting both U.S. and foreign decedents,
surviving spouses who are not U.S. citizens do not benefit from the unlimited
marital deduction available to U.S. citizen surviving spouses (unless a
special purpose “qualified domestic trust” is formed). The existing
France-U.S. estate tax treaty limits the scope of U.S.
assets subject to U.S.
tax, but does not increase the $US60,000 exemption
as do several other countries’ treaties. However, the treaty does provide an
enhanced marital deduction equal to the greater of $US250,000
or one-half of the adjusted U.S.
The proposed changes to the treaty will allow the estate
of a decedent domiciled in French a U.S. estate tax exemption equal to a pro
rata portion of the amount to which a decedent domiciled in the U.S. would be
entitled. The U.S.
will also be required to exempt (for estate and gift taxes) marital transfers
up to this same level (i.e., $US2 million increasing to $US3.5 million in
2009, then decreasing to $US1 million after 2010). Once enacted, tax refunds may be claimed
for gifts made or deaths occurring after November 10, 1988 provided they are
filed within 12 months of entry into force.
France imposes its
inheritance tax on worldwide assets of decedents and donors resident in France.
Nonresident decedents and donors are taxed only on assets located in France.
The tax is levied at graduated rates up to 60% after exemption of between
1,500 Euros and 50,308.18 Euros (rates and the amount of exemption depend on
the degree of family relationship).
The France-U.S. estate tax treaty overrides French tax law to provide
exemption with progression for U.S.
estate and gift taxes paid on transfer of U.S. assets.
How Does the Tax Treaty
This article considers U.S. Federal, but not U.S. state
and local income and transfer taxes.
Also not discussed are alternatives for avoiding U.S. estate
and gift taxes and probate by using a separate legal entity or entities to
real estate. French investors in U.S. real
estate should be aware of the issues and plan their investments accordingly
in order to reap the maximum tax savings.