THE INTERNATIONAL TAX ADVISOR

by:  Douglas J. Kingston, CPA/MBA  • Mailing Address: 16443 N 59th Place; Scottsdale, AZ 85254

• Telephone: +1 (602) 595-5885 (GMT-7) • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/

TAX ISSUES FOR FRENCH INVESTORS IN U.S. REAL ESTATE

 

Background

 

 

Rental Income and Expense

 

 

Annual Wealth Tax

 

 

Gain on Disposition

 

 

Estate, Gift and Inheritance Taxes

 

 

How Does the Tax Treaty Affect You?

 

 

Sample Picture

 

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.

 

Background

 

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.

U.S. 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 Expense

 

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 French national.


Gain on Disposition

 

The income tax treaty does not override U.S. tax rules for gains derived from disposition of U.S. real estate

 

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.  The U.S. 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 Inheritance Taxes

 

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. gross estate.

 

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 Affect You?

 

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 own U.S. 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.

 

 

Douglas J. Kingston is an Arizona certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be reached by:

Telephone: (602) 595-5885 E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/