What is the most tax-effective way to invest in US real estate?
As an accountant working with Israelis investing in real estate, I’m often asked the following question: what is the most tax effective way to invest in US real estate? The answer to this question depends on whether you are a US citizen or an NRA (with only Israeli citizenship).
If you are a US citizen living in Israel, the ideal way to invest is through an LLC. This allows both for lower individual tax rates as well limited liability protection. Also, if you made Aliyah in the last 10 years, this income will be exempt from tax in Israel. After 10 years, you can choose between paying a flat 15% on the gross rent or claiming expenses and the foreign tax credit. By claiming depreciation over 25 years (27.5 years in the US) you can sometimes accomplish positive cash flows while paying minimal or no tax in both countries. In addition, after death US citizens enjoy a sizable $13,990,000 estate tax credit against any estate that may otherwise be imposed. While this option is pretty straightforward, we recommend consulting with an international tax professional regarding the set-up of your LLC, as this may have tax consequences in Israel.
The question becomes much trickier when dealing with non-US citizens investing in US real estate. This is because the estate tax credit for NRAs is only $65,000. This means that if they die before selling their property, the IRS can impose a maximum 40 percent tax on the value of their estate in excess of the credit.
Non-US citizens can avoid the estate tax by investing in real estate through a foreign corporation. However, foreign corporations investing in US real estate are subject to an additional branch profits tax at the rate of 30 percent (Israeli companies pay 12.5 percent per the treaty) on top of the regular 21 percent corporate tax. Using an Israeli company to invest in US real estate can accrue an effective tax rate of 54 percent adding the Israeli corporate and dividend taxes plus the branch profits tax.
An alternative investment structure for Israelis that avoids both the estate tax and the branch profits tax is to use an Israeli corporation that in turn invests in a US C-Corporation, leaving minimal profits in the US corporation and distributing a portion of the profits either as a salary or as dividends (depending on your Israeli tax bracket). When planning this option, careful attention must be paid to both the cash flows and the profits generated from the real estate investment as well the personal tax situation of the investors.
