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 TREATY ISSUES FOR GERMAN INVESTORS IN U.S.  REAL ESTATE

 

Background

 

 

Rental Income and Expense

 

 

Gain on Disposition

 

 

Estate, Gift and Inheritance Taxes

 

 

How Does the Tax Treaty Affect You?

 

 

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It is important for German investors in the U.S. to review their estate plans in order to take advantage of the Germany-U.S. tax treaty.

 

Background

 

Tax rules applicable to foreign investors in U.S. real estate are often less favorable than those applicable to U.S. citizens and residents.  However, certain German investors are entitled to special U.S. and German tax benefits under the Germany-U.S. income and estate tax treaties.

 

In general, a tax treaty is a written agreement between two countries providing uniform bilateral tax rules intended to avoid double taxation of their crossborder citizens and/or residents.  Tax treaty provisions override each signatory country’s own tax laws and may be invoked by the taxpayer if the treaty rule provides a lesser tax than domestic law of the taxing country.

 

This article focuses on some of the more common U.S. and German tax issues encountered by German resident individual investors in U.S. real estate (not U.S. citizens or “greencard” holders).

 

Rental Income and Expense

 

Under U.S. domestic 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 39.6% and 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.  In addition to ordinary and necessary expenses, allowable tax deductions include straight-line depreciation computed over 27.5 years for residential property and 39 years for commercial property.

 

Under German domestic tax law, a German resident’s overseas net rental income is subject to graduated tax at rates up to 53% (with credit for foreign country income taxes paid).  However, the Germany-U.S. income tax treaty overrides domestic law with the result that U.S. real estate rental income is exempt from German income tax.  Though not taxable, the exempt income is taken into account in determining the tax rate on other German-taxable income (this is known as the exemption-with-progression rule).

 

 

 

Gain on Disposition

 

The Germany-U.S. income tax treaty does not override U.S. tax rules for gains derived from disposition of U.S. real estate.  Thus, a German investor’s net U.S. real estate gain is generally subject to graduated rate taxation under the regular tax or AMT rules.  For dispositions after May 7, 1997 U.S. gains-taxation is generally limited to a maximum rate of 20% for property held more than 12 months (except that gain attributable to prior depreciation is taxed at a maximum rate of 25%).

 

Under German domestic tax law, a German resident’s overseas real estate gain is subject to graduated tax at rates up to 53% (with offset for any foreign country income taxes paid).  However, the Germany-U.S. income tax treaty overrides domestic law with the result that U.S. real estate gain is exempt from German income tax under the exemption with progression rule.  Some commentators are of the opinion that U.S. real estate losses, especially those attributable to currency fluctuations, are deductible in Germany even though gains are tax exempt under the treaty.

 

Estate, Gift and Inheritance Taxes

 

Under U.S. domestic tax law, the value of U.S. assets of a nonresident decedent who is not U.S. citizen is subject to tax at graduated rates up to 55% after exemption of only $US60,000 (a U.S. citizen is entitled to an exemption of $US650,000 increasing to $US1 million by the year 2006).  The Germany-U.S. estate tax treaty increases the exemption to one-half the value of U.S. assets transferred to a surviving spouse.

 

Under its domestic tax law, Germany taxes the value of the worldwide assets transferred (if either the decedent or beneficiary is resident in Germany) at graduated rates between 30% and 50% after exemption of between DM10,000 and DM600,000 (rates and the amount of exemption depend on the degree of family relationship).  The Germany-U.S. estate tax treaty provides a credit against German inheritance tax for U.S. estate 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.  German investors in U.S. real estate should be aware of the benefits available under the Germany-U.S. income and estate tax treaties, 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) 595-5885E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/