Transparent or Opaque Ownership Structure?
Can you see what is behind the veil
Setting up a separate entity creates a corporate veil so far a legal responsibility is concerned. Whether the veil is transparent or opaque decides whether the entity will file its own taxes.
Before delving further in tax matter, we pause to consider how exciting the matter of veil transparency is in the arts... The veil can either be transparent as in the sculptor's masterpiece below,
Veiled Vestal by Corradini (1743).
or it can produce an even more imaginary excitement as for the "black veil" mentioned in Northhanger Abbey, a classic novel where two girls read about a veil in the Mysteries of Udolpho, a popular gothic novel:
“But, my dearest Catherine, what have you been doing with yourself all this morning? Have you gone on with Udolpho?” “Yes, I have been reading it ever since I woke; and I am got to the black veil.” “Are you, indeed? How delightful! Oh! I would not tell you what is behind the black veil for the world! Are you not wild to know?” “Oh! Yes, quite; what can it be? – But do not tell me – I would not be told upon any account. I know it must be a skeleton, I am sure it is Laurentina’s skeleton. Oh! I am delighted with the book! I should like to spend my whole life in reading it, I assure you; if it had not been to meet you, I would not have come away from it for all the world.”
Why most people own US real estate directly or through a fiscally transparent entity?
When considering US taxation only, owning real estate in a LLC means that rental net income is taxed as only the ultimate beneficiary need to file a return and pay taxes. Owning it in a fiscally opaque entity (one that files its own return) would result in the entity paying income taxes, and the beneficiary paying some as well.
For a US resident, the transparent setup is not only the simplest setup, it is also the most efficient.
The elephant in the room: how your tax jurisdiction treats US income
Some tax jurisdiction (Hong Kong for example) apply territorial taxation, which means that only domestically sourced income is considered for tax. Some others (France for example) apply taxation on global income, with tax treaty only ensuring there is no double taxation (you still pay the highest possible tax).
In the case of France, owning US rentals directly or through a fiscally transparent LLC results in your having to maintain a set of accounts for the IRS, and then another set of account for the french tax authority, as they follow different rules for deductions. See this article in french.
This means that it makes sense to own directly a house from Hong Kong, whereas owning a property for a french beneficiary is best done through an opaque entity (i.e., an entity that has its own accounts and files for tax separately).
Foreigners: alleviating the impact of double taxation
As the tax rate for companies is quickly higher for companies than for individual, if interest are taxed lower than company income, the founder will loan the company the funds needed to buy the real estate rather than contribute the funds as equity, leading to an interest charge reducing its net income, and tax on interest being levied on the owner instead.
This is not efficient in Hong Kong where interest witholding is 30%, but interesting in France where there is no US withholding on interest income. See here for more information on tax treaty rates.
US and Foreign Person: Avoiding Estate Tax
Corporations also allow some estate planning deals, such as creating a company for which one's children are shareholders. As the company initially has very little equity initially and its assets have been financed with debt, this is an efficient way to transfer income producing assets.
This information has been gathered from friends and internet sources. I recommend you speak with a tax advisor proficient with your tax jurisdiction.
We will have another article on the question of avoiding probate for your US properties.
as the new tax bill brings tax down to 9% for the first 70k of passive activity, and capped at 25%, whereas corporations will be taxed at 20%, we can expect a renewed interest for real estate investment in the USA.
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