Are you thinking about buying real estate in another country? You may be looking at a vacation home, a place to retire, an investment opportunity, or a source of passive income. Buying foreign real estate can be an attractive and less-expensive option than a similar investment in the United States.
Before you buy, you’ll need to understand the tax implications and filing obligations of purchasing foreign real property. Risks and issues will inevitably arise, but careful planning and help from tax professionals can ease the process and put more money in your pocket.
Local Country Tax Laws
In addition to U.S. laws, each country has its tax system and rules that may apply to your purchase. It‘s imperative to consider the country, state, and local tax laws in the country where you’re buying real property. Taxes may include:
Real property taxes: Not all countries impose a property tax, and if they do, it’s likely much lower than similar investments in the U.S. These taxes can vary based on factors such as the real property’s value, location, and usage.
Stamp duty or transfer taxes: Some countries require you to pay stamp duty or transfer taxes when purchasing real estate. These fees are similar to U.S. capital gains taxes, are typically based on the real property’s value, and cover the legal costs associated with the transfer of ownership. Transfer taxes can be much higher than in the U.S.
Value Added Tax (VAT): VAT and similar taxes—e.g., GST in Canada—are consumption taxes imposed on goods and services. They may also apply to real property purchases in certain countries. In addition, you may have to pay VAT if you rent out your property.
To avoid unexpected costs, you’ll need to understand whether VAT—and its associated rates—applies to real property transactions in the country of your purchase. If you rent it through an online company, VAT may be applied automatically to the rental charges.
Local country income taxes: In some cases, the local country will levy income taxes on income derived in connection with the property. With careful planning, you could avoid creating a taxable presence and income tax in the foreign country.
Example: A Californian Buying Real Property in Mexico
Mexico’s proximity and climate make it a favored destination for Californians who want to buy real property abroad. However, there are significant differences between owning real property in the U.S. and Mexico, including tax rates, assessment methods, and exemptions. Some differences include federal VAT on lease payments and city taxes on real property in Mexico City.
If you’re a U.S. taxpayer planning to buy real property in Mexico, consult U.S. and local Mexican tax experts to assess your tax liabilities accurately. Also, take the following into account:
Cross-border taxes: Understand how Mexico and the United States tax real property-related income and expenses. For example, both countries may tax rental income from real property. Your tax adviser can explain tax rules and reporting obligations for each jurisdiction. They can also help identify tax planning opportunities and strategies to minimize liabilities.
Foreign ownership restrictions and regulations: Mexico has restrictions on foreign real property ownership, particularly in designated “restricted zones” near the coast. Make sure you understand these regulations—and potential workarounds, such as establishing a Mexican corporation or trust.
Residency requirements and implications: A person can unknowingly trigger residency in Mexico, which may have tax implications. Your tax adviser can tell you the residency requirements and potential tax benefits or obligations.
Tax on Rental Income
If you plan to rent out your property, keep in mind the potential tax implications for rental income:
Income tax on rental income: Renting out your property may trigger a permanent establishment, subjecting you to local income taxes on rental income. Understanding the rules and thresholds for permanent establishment is crucial for tax compliance
Rentals through Airbnb or VRBO: Certain tax-related aspects may apply if you rent out your property through platforms like Airbnb or VRBO. Some countries require these platforms to report rental income on behalf of hosts, while others may hold the host responsible for reporting and remitting taxes.
Holding Foreign Real Property in an Entity
Creating an entity can be an efficient way to purchase foreign real property, especially if the property will generate rental income. However, creating an entity in a foreign jurisdiction has significant tax implications abroad and in the U.S. For example, a U.S. owner or shareholder in a foreign entity, including a branch or flow-through entity, will trigger a U.S. filing requirement and tax inclusion. Compliance can be complex, and penalties for missed filings could be significant—we recommend consulting with both U.S. and foreign tax advisors before creating a foreign entity.
Wealth + Inheritance Taxes
Some countries impose wealth or inheritance taxes on real property owned by non-residents. Some of these laws include:
Gift vs. inheritance tax: Different tax rules may apply depending on whether the real property is received as a gift or through inheritance.
U.S. tax based on the situs of real property: The United States has its own tax rules for foreign real property ownership. The U.S. taxes its residents on their worldwide income, including rental income or gains from selling foreign real property.
Tax treaties mitigate disputes and discrepancies between two countries’ tax laws. The U.S. has treaties with many countries around the world. They’re the dominant law for conflicts between the tax rules of two countries, often dictating which country may levy income and real property tax, a taxpayer’s residency, and other issues. Understanding tax treaties and their interactions with U.S. and foreign tax laws can help you avoid double taxation.
Reporting + Compliance Obligations
Owning real property in a foreign country may come with reporting and compliance obligations.
Reporting requirements: The United States requires its residents to disclose foreign financial assets under the Foreign Account Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR). Although the purchase of foreign real estate may not trigger these filing obligations, buying or maintaining property can. In addition, the purchase of real property may trigger a taxable presence and income tax in the local jurisdiction, resulting in a U.S. filing obligation.
Potential penalties for non-compliance: Failing to meet reporting and compliance obligations can result in substantial fines. The IRS has increased its focus on international tax compliance in recent years, making it a must to fulfill all reporting obligations accurately and on time.
Tax Planning + Strategies
To minimize tax liabilities and ensure compliance, consider these tax planning strategies:
- Learn the optimal ownership structure for cross-border taxation: The choice of ownership structure can have significant tax implications. Consult with your tax professional to determine your most advantageous ownership structure.
- Identify how you will use the real property: Since using the property as a rental, a personal vacation home, or both can have different consequences, discuss its use with your tax advisor to mitigate tax and compliance issues. Also, consult with your tax advisor if the use changes.
- Properly time your real property’s purchase and sale: The timing of a real property’s purchase and sale can impact tax liabilities. Understanding the tax consequences around timing your real property transactions can help maximize tax benefits and minimize tax burdens.
- Keep accurate and comprehensive records: Proper documentation of income, expenses, and transactions related to your foreign real property will facilitate compliance and minimize potential issues during tax audits.
Protecting Your Real Property Investment with Aldrich
The tax implications of purchasing foreign real estate are complex, requiring the help of professionals in the U.S. and overseas. Aldrich belongs to several global networks of advisors and works closely with foreign tax professionals, attorneys, and other service providers—we can recommend a trusted advisor wherever you need one.
Here in the U.S., our professionals will work with you to minimize your U.S. and foreign tax liabilities and help you comply with regulations. If you’re ready to buy or sell real property overseas, let’s talk.
Meet the Author
Senior Manager, International Tax
Nick Uren, JD, MBA
Nick Uren joined Aldrich CPAs and Advisors in 2022. Nick specializes in international tax and mergers and acquisitions. Before his career at Aldrich, Nick worked for several years at two Big 4 accounting firms and most recently was a leader with Grant Thornton’s Pacific Northwest international tax practice. Nick graduated with his bachelor’s in business... Read more Nick Uren, JD, MBA
- Licensed attorney in Oregon and Washington
- International tax compliance
- Mergers and acquisitions
- Inbound and outbound tax law
- Foreign entity planning and global structuring
- Cross-border IP planning
- Cross-border intercompany transactions