IRS Rescues Non-Resident Alien Owning U.S. Real Estate and Residences

International tax planning and strategy

Applying for an IRS ruling on your international tax planning will save you taxes in the long run.

The British Virgin Island (BVI) corporation is used by many non-residents aliens  (NRA) to own real estate and their personal residences in the U.S.

When the property is sold, an excessive tax is paid.   Instead of being taxed at 15% to 20%, the corporate income tax rate is 35%.  After paying the corporate income tax, a foreign corporation also pays the branch profits tax.  This tax is 30% of the net income.

Removing  the real estate from the corporation caused a “double taxation”.    A corporate (domestic or foreign) distribution of  property is taxed as if the corporation sold the property.  Second, when the shareholder receives the property, he or she is taxed as if they have received a dividend.

Estate Tax for the Non-Resident Alien owning U.S. property with a Foreign Corporation.

About 15 years ago, the IRS won estate tax cases using section 2036.  This law puts assets of a foreign corporation in the alien’s taxable estate if he can enjoy the corporate property or  the corporate income.    Since the estate tax exemption for the non-resident alien is $60,000 or less, a large estate tax is due.

Because of the foreign corporation owns the real estate,  the corporate income taxes described in the first paragraph can apply either in whole or in part.

The IRS has come up with a method to solve the income tax problems.   The method is called a “dual resident corporation.”

A dual resident corporation has two corporate charters.  One charter is issued by a foreign government.  The other charter is issued by a State.  For example, a BVI corporation owns a home.   The corporate files for a charter to be a Delaware corporation.  The corporation now has two corporate charters.

The IRS allows such a corporation (if owned by Americans and residents) to elect the be taxed under Subchapter S.  Thus, any gain on the sale of the property is taxed by the individual shareholders at the 15% or 20%  long-term capital gain rate.

The foreign corporation branch profits tax does not apply because the corporation has two corporate charters (one of which is American).

Once Caveat:  A foreign corporation converted to a Subchapter S corporation has to wait 7 years to sell its appreciated property to avoid the double taxation discussed in the first paragraph.

However, the double taxation applies only to the amount of appreciation of the real estate (also known as “built-in gain”) at the time of converting to an S-corporation.   For example, the BVI corporation purchased a home for $100,000.  A few years later it becomes an S-corporation.  At that time the home is worth $200,000.  A few years later, the home is sold for $400,000.

The gain of $300,000 is a long-term capital gain.  An additional tax is charged on the gain of $100,000 ($200,000 minus the cost of $100,000).

One of the hidden savings of the dual resident corporation is the low cost of a domestic tax return.  A foreign corporation owning U.S. real estate must file a complicated Form 1120F.  The cost of preparing a Form 1120F is three to four times the cost of a domestic corporation tax return.    In additionally, a foreign corporation has special reporting because of a tax law known is the Foreign Investor Real Property Tax Act (FIRPTA).

“Last in Time” Rule Voids Most of US Tax Treaties

Europeans, Australians, and Canadians may think they can rely on their country’s tax treaty with the United States.   But, this is not the case.  The U.S. has a little-known law called the “Last in Time Rule.” 

The Last in Time Rule makes many treaties worthless.   Back in 1986, the Republican-controlled Congress enacted legislation repealing every tax treaty provision that conflicts with any new tax law.

For example, in the tax court case below, a Canadian filing a US tax return exempt from a second US tax (known as the alternative minimum tax “AMT”) based on the Tax Treaty.  The U.K.U.S Tax Treaty and the French-U.S. Tax Treaty have a similar concept. 

However, since this second tax was modified (regarding the “foreign tax credit”) after the Tax Treaty was signed, the Tax Treaty was void (as to the AMT).  The “Last in Time” tax law voids any treaty tax savings that relates to a law enacted or changed after the Treaty was signed.

Here are the details of  William David Jamieson and Judith A. Jamieson vs. Comm’r a Federal District Appeals Court ruled that the reduction of the alternative minimum tax’s (AMT) for foreign taxes paid to Canada was disallowed.   While the Canadian -US tax treaty allows the tax savings, the treaty was void.

Under the Treaty, taxpayers were to be allowed a full tax credit for taxes paid to the other country.   After the Treaty had been signed,  tax code section 59(a)(2) was enacted as part of the AMT.

Want to take your tax planning to the next level, then contact me, Brian Dooley, CPA, MBT  at [email protected]

Here is a summary of the case:

In affirming the  Tax Court  by ruling that a U.S. couple who resided in Canada is liable for alternative minimum tax on the income earned in Canada, agreeing with the Tax Court that their foreign tax credits were limited by section 59(a)(2) and that the tax treaty between the United States and Canada does not preclude their liability because of the last in time rule.

This is a major rule that many  CPA’s and attorneys ignore.  Here is the footnote from an Appeals Court case citing the Supreme Courts creation of the last in time rule. This also applies to conflicting parts of the tax code and regulations.

[16] When a statute conflicts with a treaty, the later of the two enactments prevails over, the earlier under the last-in-time rule. The rule and its rationale were articulated by the Supreme Court in Whitney v. Robertson:

      By the constitution, a treaty is placed on the same footing, and made of like obligation, with an act of legislation. Both are declared by that instrument to be the supreme law of the land, and no superior efficacy is given to either over the other. . . [I]f the two are inconsistent, the one last in date will control the other . . . If the country with which the treaty is made is dissatisfied with the action of the legislative department, it may present its complaint to the executive head of the government, and take other measures as it may deem essential for the protection of its interests . . .

The duty of the courts is to construe and give effect to the latest expression of the sovereign will

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