Taxes on Real Estate Investment Property in USA for Foreign Nationals
In this video we discuss the taxes on real estate investment property in the USA if you are a foreign national. Many foreigners invest in real estate in the United Stated and they want to know how much in taxes are they going to pay. In this video we discuss the tax differences between investing in real estate as an american citizen or as a foreign national. We are also going to discuss if you should buy real estate under your name or under an LLC. We will show you an example of how much taxes will a foreign national pay from its rental property income.
This video is intended for education purposes and should not be taken as legal, financial or tax advice. You should consult with a professional about your unique situation before acting on anything discussed in these videos. Freedomtax Accounting and Multiservices Inc., Freedom Insurance Financial Inc., Freedom Realty Source Inc., and Freedom Immigration International Inc. are providing educational content to help small business owners and individuals become more aware of certain issues and topics, but we cannot give blanket advice to a broad audience. Freedomtax Accounting and Multiservices Inc., Freedom Insurance Financial Inc., Freedom Realty Source Inc., and Freedom Immigration International Inc. or its members cannot be held liable for any use or misuse of this content.
One of the most common questions that we get here at FreedomTax Accounting is, how much taxes do I have to pay if I am investing in real estate or have a rental property in the United Estate as a foreign national? That’s what we’re going to talk about in this video.
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Now as mentioned, here at FreedomTax Accounting we have helped a lot of foreign nationals that are investing in real estate in the United State, to comply with their tax requirements, and we have always tried to help them as much as possible with effective tax strategies. So, what will we talk about in this video? Basically we’re going to show you if there’s a difference in investing in real estate as a US citizen or as a foreign national; very important we’re going to show you the difference on buying your rental property under your name, or is it better to buy the rental property under an LLC or a registered business in the US; we are going to show you how rental property taxes work and how much you need to pay; we’re going to show you the most common tax deductions or rental property expenses then you can deduct from your rental income to lower your tax liability. Very important that we are going to show you how depreciation works, because that’s one of the things a lot of foreign nationals ask about, how exactly can I depreciate my rental property in my tax return? And most importantly, at the end we’re going to show you an example with numbers, so first we’re going to go through the theory and then at the end we’re going to show you an actual example with numbers so you have a concrete idea on how much taxes you’re going to pay from your rental property.
Remember that the information provided in this video in general information, every case can be different that is why we always suggest that you talk to a tax professional to discuss your specific case, because your specific case may have certain exceptions that you can have more tax advantages or the information, we discussed in this video can be a little bit different in your specific case. If you want a consultation this is our contact information and we will gladly schedule a consultation for you to evaluate your case and give you the best tax strategy for your rental property business.
Now, first let’s go into, what’s the difference, if there is any, in buying a rental property or an investment property as a US citizen or as a foreign national?
The reality is that there’s not a lot of difference. Once again, there are some cases that there may be a difference, but most of the time the amount of taxes that US citizens pay versus foreign nationals, the amount of taxes they pay are usually the same, exceptions come when your net annual rental income is super high; then maybe yes, US citizens may get a tax advantage which we will discuss further along in this video.
Now, also remember as a foreign national the amount of down payment that you pay for a rental property may be higher compared to a US citizen, but it at all depends on the mortgage broker or the mortgage company or the mortgage bank that you are working with; but usually mortgage banks, they usually require that if you are foreign national, that you give a higher down payment versus if you’re a US citizen. Also, foreign nationals must apply for an ITIN number from the IRS.
What is an ITIN number? Here in the US we have what are called tax identification numbers; usually if you are a US citizen, you tax identification number is your social security number; but if you are a foreign national, that you cannot apply for a social security number, so the government has a number called the ITIN number, which is a tax identification number for an individual that cannot apply for a social security number; so, that’s one of the main differences between buying real estate as a US citizen and a foreign national. If you need an ITIN number, that’s something that’s also a service that we provide here at FreedomTax Accounting.
Now, what’s the difference between buying your rental property under your name, under your personal name, or under an LLC or a registered business in the United State? In most cases there’s basically no tax difference, so in most cases there’s really no tax advantage if you buy properties under your name or under an LLC. The LLC, yes, provides tax advantages when the annual rental net income is super high and we’re going to show you in the example further along in this video but in most cases there’s really no tax advantage unless you’re making very high annual rental net income; then yes, the LLC can give you a tax advantage. But the main advantage of the LLC is basically legal asset protection, and I want to discuss this a little bit in more detail okay.
If you buy a rental property under your name, now you are personally liable for anything that happens in that rental property, so you buy a rental property under you name, you start renting it out, God forbid, something happens in the rental property; if there is a lawsuit, the lawsuit is against you as a person, so that means that your personal assets are at risk. Now, if you buy a rental property under an LLC, even though you are the owner of the LLC, the actual business that is renting the property is the LLC, not you as a person; so, you’re renting your property under the LLC but the owner of the property has to be the LLC; God forbid something happens, there’s a lawsuit, the lawsuit is against the LLC, so your personal assets are protected.
So, that’s the main advantage of buying rental properties under an LLC, is for the legal protection; and in most cases a lot of people talk about having legal protection from the LLC towards yourself, but you are also providing protection from yourself towards the LLC; because let’s say that the LLC owns the rental property, but now you get in trouble as a person, then your rental property is protected from you. So that’s the main advantage and we always suggest that you buy rental properties under an LLC especially if you want to grow; and we’re going to show you later on in the example.
Now, let’s talk about how rental income taxes work if you buy a rental property under your name, under your personal name. How does the taxes work?
Basically, you make your rental income and that rental income gets reported on a tax form called the Schedule E. Now, how does Schedule E work? You make your rental income and then during the year you have all your tax deductions and rental income expenses; at the end of the year, you have your net profit or your net loss. Now, this is your tax return, if you are a foreigner, you should file form 1040-NR, which is the individual tax return which you file every year, once a year, to report your rental income; so, this is the form the 1040-NR. Now to file, the 1040-NR, you must have an ITIN number, that’s the reason you need the ITIN number, so you can file your personal tax return at the end of the year.
Now, remember you made your rental income, you have all your expenses, you have your net profit, this net profit gets reported on your personal tax return as a foreign national and you only pay the federal tax which starts at 10%. The important thing here is that you don’t pay the high 15.3% self-employment tax. If it were any other type of income, you would have to pay this tax as well, but since you are reporting rental income, which is considered passive income then you don’t pay the high social security tax and you only pay the federal tax. Now, how much federal fax? It depends on the amount of rent or net profit.
Now, this will get taxed, this is the tax brackets, (remember this is the 2021, these are the tax brackets that are current at the moment of recording this video, this table can change in the future but usually doesn’t change that much); but if you net profit is under $9.875, that’s why you pay the 10% tax rate; and then as your net, not your gross rental income, the net rental income, after the expenses, as they grow then you’re going to higher tax bracket; so that’s the way taxes work if you buy a rental property under you name.
Now, let’s see what happens if you buy rental properties under an LLC. If you form an LLC with one owner, the automatic designation for taxes is that that LLC is going to file its rental income and report its rental income under the same Schedule E as the individual, even though it’s an LLC that owns the property; so you’re going to have to do a Schedule E that goes inside, once again, a personal tax return, which is the 1040-NR form, so even though it’s an LLC doing the work, if it’s a single member LLC, LLC with one owner, the automatic designation for taxes is the same schedule E as if you were buying rental property under you name; and it’s the same thing, you’re going to make you rental income, you’re going to deduct your rental expenses, you’re going to have your rental net profit or loss; if you have a loss, no taxes, but if you have a profit this gets reported on the personal tax return the owner of the LLC, and once again it pays the federal tax that starts at 10%; and you are subject to the same tax rates as if you were buying the property under your name. So, see how there’s basically in most cases there’s not a tax advantage if you buy properties under an LLC or under your name, the LLC is more legal asset protection, that’s the main advantage of the LLC.
Now, let’s talk about if the LLC has a tax advantage when there is high annual rental income. Remember that if this rental income here is super high, meaning that you are more or less from this tax bracket down, so if you’re making net annual income, net profit, of this amount or more, then maybe you should not file taxes this way, because you’re going to pay the high tax bracket. In those cases what happens is, the advantage of the LLC is that it is flexible on how it can file taxes. Once your reach that point of rental income, you can tell the IRS that you don’t want your LLC to pay taxes under the Schedule E, and you can tell the IRS that you want your LLC to pay taxes as a corporation under form 1120; in this case, this net profit does not flow through the owner’s tax return, but it pays a flat, right now is a flat 21% corporate tax, which is a lot lower than 32%. The 21% corporate tax is the current rate, the current administration wants to increase this to 27 or 28%, but it’s still lower than the 32% over here.
Now, what happens is usually once a rental property business reaches this amount of net profit, you usually have a lot of properties, because it’s very weird to have this amount of net rental income from a few properties. Now, once it reaches that point what usually happens is that you’re going to have an LLC which is going to be your holding company, and you will be the owner of this LLC; but then you’re going to have other LLCs with properties, so you don’t put all your properties under one LLC, you form several LLCs to put different properties so you spread out the risk; and then this holding company is going to be the owner of all these LLC’s. The advantage there is that you will not have to file a tax return for every single LLC, because what happens on these LLCs will always flow to this main holding company, that’s a more advanced tax strategy which we can discuss later on.
Now, what happens if you have an LLC that has two or more owners? If you have an LLC with two or more owners basically what happens is that the automatic designation for taxes is not the Schedule E, it’s a form called the 1056 partnership form. This form is a separate form that is not the personal or the owner’s personal tax return, so it’s a separate form and you have one owner and let’s say you have two owners, so you report your rental income under form 1065; you have your rental income, you have your expenses, you have your net profit or your loss; this net profit you have to do a 1065 form, which is a separate tax return, but you don’t pay corporate tax; this net income gets split between the owners depending on the percentage of ownership of the LLC, so if owner number one is 50 % owner of the LLC and owner number two is 50% owner of the LLC, then this net profit is 50% over here and 50% over here. It doesn’t have to be 50-50, it can be 70% and 30%, any percentage that you want. So, the percentage of the ownership gets reported on a personal tax return that each owner needs to file, so each owner needs to file a 1040-NR form, so they can pay the federal tax for the amount of income that gets reported on their personal tax return. And once again, this starts at 10% because each owner is going to have to pay taxes according to this tax table. So, remember that, so that’s the difference between buying real estate under your name or buying real estate under an LLC, as you can see the taxes are more or less the same, there is a difference once you have higher net income, once you have a lot of properties, then you can take the tax advantage of the LLC, but the advantage is more legal asset protection.
Now, let’s go into the example. In this example we’re going to use a property that you buy for $150.000 dollars and that property has $1.000 dollars monthly rental income; so that means that your annual rental income is $12.000 dollars, you can deduct, now we’re going to talk about the tax deductions that you can have on your rental property, you can deduct what you pay to your property manager, which is usually from 8% to 12% of the monthly rental income; you can deduct repairs and maintenance, which is always good to separate, 5% of the monthly rental income should go into repairs and maintenance; you can deduct your homeowners association, now this can be higher or lower and this can be even zero, because not every community has a homeowner’s association fee, there are many properties that don’t pay HOA, so if that’s your case it’d be zero; you can deduct your insurance of the rental property; you can deduct property taxes, and once again property taxes depending on where the residential property is, or the rental property is, it can be higher or lower but the national average is 1%, that’s how I got the $1500, but any property taxes that your property pays it is a tax deduction; you can deduct professional fees, for example whatever you pay your CPA to do your tax returns at the end of the year; if you have an LLC, you have to file your state annual return or annual report for you LLC, so if you need to pay a lawyer, if you need to pay your realtor, all of that you can deduct as professional fees; you can also deduct license and permits, depending where the property is, you may have to have a license or a permit to rent it out, but usually it’s not, so usually this is zero, but in other states and other counties, yes, you have to have a license or a permit to rent out the rental property; if you buy your rental property in a mortgage, then you can deduct the mortgage principal and the interests, and this is usually the mortgage and the interest for a property that you buy for $150.000 dollars; if you pay your property cash and you don’t have a mortgage, then that’s another thing that’s zero; you can also deduct your utilities, meaning the energy, the power, the electricity, the water, usually the landlord or the owner of the property don’t pay these, usually the people who are renting the property they pay their utilities, so that’s why I left this in blank; and also if you travel for business, if you need to travel from your country to the US to take care of anything related with your rental property, you can deduct your travel expenses as well, your airfare, your hotel while you’re in the US, the car rental, your meals while you’re in the US doing business of your rental property, you can have those travel expenses deducted as well.
So, if we take the $12.000 and we have all these deductions, then the annual net profit would be that. That’s what basically is left over from your rental income. Now, from that, we can now deduct for taxes depreciation, in this case the depreciation is $3818, but how did I come up with that depreciation number.
Now, for depreciation what you need to know is that, remember for this case the value of the home is $150.000, you cannot depreciate the entire home value, why? because the land where the property is has a value and the property itself has value, you cannot depreciate the land, you can only depreciate the property. Now, there are many depreciation formulas, the most common one is that you take 70% of the property value, plus improvements, let’s say that you build a pool that you put a new roof on the property, those type of improvements you cannot deduct like entirely in one year, you have to depreciate those capital improvements. In this example we’re not going to put any improvements. So, for this example we take $150.000 dollars and $105.000 dollars is 70% of the property.
Now, we need to take $105.000 dollars which is 70% of the property, and we divide it by 330 months, because you can depreciate it for 27 and a half years, 27 and a half years is 330 months; so, in this case we can deduct $318 dollars per month in depreciation, so $318 dollars per 12 months, that’s one year, that’s how I came up with the depreciation number; so, from your annual net profit, we deduct now for taxes the depreciation and now you have an annual net profit of $2812; your cash flow it’s this $6630, but from your cash flow you deduct the depreciation and this is what you report to pay taxes. Now, you take this $2812 net profit and you go to the tax table, as you can see it is in this tax range, so that means that you’re going to pay a 10% tax rate, so you’re going to pay $281 dollars and 20 cents in taxes. So, that’s how taxes for rental properties work.
Remember, this is general information, every case can be different. We always suggest that you schedule a consultation with a CPA or tax professional, so they can evaluate your specific case.
Here at FreedomTax we can give you that consultation, we can help you open up the LLC in any US state, and we can also help you get your ITIN number, and we can also file the annual tax returns that need to be done. So, we’re basically like this one stop shop and we can help you in all your rental property tax needs.
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