Overseas Real Estate Investments & Taxes

The rise of real estate crowdfunding platforms has expanded the potential property investment pool for investors to areas around the world. For U.S.-based real estate investors, the benefits of investing in property overseas are many. From predictable investment returns to standard tax breaks and more, it’s easy to understand the popularity boom.

Before you even begin to consider a jump into the foreign real estate investment pool, it’s important to become as knowledgeable about the entire process as possible. One item that is particularly important to research and understand is the tax implications that go along with property investing overseas. 

Your U.S. Tax Implications

Investing in real estate via crowdfunding carries with it some tax issues that are unique from more traditional real estate investing. The first thing to understand is that real estate crowdfunding is a form of real estate syndication. As an equity investor in a syndication, you are actually a partner in partnership, and investments in syndications will generally be considered “passive” activities.

“For a real estate entity there are typically two sources of passive activities: (1) rental activities (rentals of apartments, commercial buildings, retail centers, etc.), unless the taxpayer is classified as a real estate professional; or (2) a business (flips, real estate development, etc.) in which the taxpayer does not materially participate. Passive activities will generate either passive income or passive loss. Interest, dividends, annuities and gains on stocks and bonds are not considered passive activities.” [source]

At the end of each year, investors receive a K1 from the syndication. This form will either report income or a loss, as well as other tax items. This information is then included on that year’s tax return following the rules for passive activities. If there is a loss reported on the K1, then the investor reports a passive loss.

There is one additional special tax advantage offered through Crowdfunding syndications. That advantage is favorable long-term capital gains rates. Property acquired through a syndication is usually held for longer than one year. Then, when that property is sold, it will typically result in long-term capital gains which are taxed at a rate of 15% in most cases. Any depreciation deducted from the property would be subject to tax rates not to exceed 25%.

Your Overseas Tax Implications

“For U.S.-based investors, the ownership of foreign property has special tax implications. These are often determined by the laws of the country in which the property lies and the citizenship status of the investor in question. In general, investors who have United States citizenship or permanent-resident status must pay American taxes on any income earned from foreign property holdings. This is true for ongoing rental income as well as for thecapital gains realized from the sale of such property.” [source]

Taxes are frequently levied on income and capital gains earned within a country’s borders by that country’s foreign governments. To help mitigate this “double taxation” problem, the U.S. maintains treaties with several other countries, most of which primarily stipulate that American citizens can’t be required to pay the same taxes twice. In countries that do not have a treaty in place with the U.S., double taxation may still occur, depending on the individual laws of each foreign jurisdiction.

The Foreign Tax Credit

There is an offering within the U.S. Tax Code that allows those that invest in foreign properties to use some (and sometimes all) of the foreign taxes paid to offset liability on your U.S. taxes. According to Investopedia, “for any ‘qualified foreign taxes’ that you’ve paid- and this includes taxes on income, dividends and interest - you can claim either a credit or a deduction (if you itemize) on your tax return.” It is important to realize that there are limits to the amount of foreign tax credit you can receive, so it’s always a good idea to discuss any potential investment opportunity with your tax specialist prior to investing.

“The amount of foreign tax you can claim as a credit is based on how much you’d be taxed on the same proceeds under U.S. tax law, multiplied by a percentage. To figure that out, you’ll have to complete Form 1116 from the Internal Revenue Service (download the form here). If the tax you paid to the foreign government is higher than your U.S. tax liability, then the maximum foreign tax credit you can claim will be the U.S. tax due, which is the lesser amount. If the tax you paid to the foreign government is lower than your tax liability in the U.S., you can claim the entire amount as your Foreign Tax Credit.” [source]

To learn more about this, visit the IRS’ website here to see the requirements for claiming foreign tax credits.

Passive Foreign Investment Companies

One important distinction to be mindful of is investing via a Passive Foreign Investment Company (PFIC). These are foreign-based mutual funds or partnerships that have at least one U.S. shareholder. U.S. tax laws treat these types of investment entities much differently than funds based offshore, and these laws can be very complex. To illustrate this point, Investopedia shares the following example: “current distributions from a PFIC are generally treated as ordinary income, which is taxed at a higher rate than long-term capital gains.

Tax Information for Dubai Real Estate Investments

Now we will examine some important distinctions that U.S. based investors should keep in mind when considering property investments within the United Arab Emirates. A focus on Dubai is particularly useful for real estate crowdfunding investments through my platform Durise. “Each emirate [within the UAE has] its own rules regarding foreign investment, and foreign ownership restrictions frequently apply. For example, Gulf Cooperation Council nationals may invest in Dubai property without restriction, but not in Abu Dhabi. As a general rule, foreign nationals can only invest in specific areas, wherein freehold land ownership may or may not be permitted for overseas investors.” [source]

The UAE does not impose income or corporation taxes, so the only taxes a US-based property investor would be liable for are those levied via U.S. tax codes, as discussed above. However, property taxes are one item to keep in mind, although they are not relevant to all property investment scenarios.

“Property taxes are levied by municipalities. These are the main taxes, if not the only taxes, that you are going to pay in the UAE. The local property tax is generally paid only by landlords who rent out their property. Thus, it is in effect a tax on rental income. In all emirates but Abu Dhabi, the rate is 5% for residential property and 10% for commercial property. In Abu Dhabi, municipal landlord license fees must be paid by landlords instead. Higher property taxes mechanically shrink property values and rental yields. Prior to purchasing property, it is essential that you check how much property taxes you can expect to pay.” [source]