COVID Funding Tips for Small Businesses
Learn how to protect your U.S. real estate before you invest. The good news is that when investing in U.S. real estate as an international investor, it is very similar to a U.S. individual investment in U.S. real estate.
For this discussion for real estate, we refer to single-family homes and multi-units that can be rented out and commercial buildings that can be leased to business owners.
Here are some common important facts:
- Never own U.S. real estate in your own name, personally (long-term). If you have a mortgage, you will have to typically close escrow in your own name personally, then quitclaim or warranty deed it to an entity (typically an LLC).
- Do not put all your “real estate eggs” in one basket. If you have four triplexes worth $500K each, that is $2-million of real estate, and if the properties are free and clear (no mortgage) by putting the real estate into one LLC, you are exposing all the equity to a lawsuit by anyone of the properties.
- You may need 2-3 U.S. entities to protect your real estate investments. The key is how they are managed and structured.
- An LLC (limited liability company) makes the most sense as an entity to protect U.S. real estate (not a Corporation, because of double taxation). The LLC would either be a two-member LLC taxed as a partnership or a single-member LLC taxed as a disregarded entity.
- If you live in California, for example, and you own property in Florida, if you form a Florida LLC to own that property, California will require that the Florida LLC register to do business in California. You have nexus (or a business presence) where you are doing the work (checking your bank balances, transactions) and where the physical property is located.
- You will need a separate bank account in the name of the LLC.
- You will need a separate EIN for each LLC.
Being international, a lot comes into play with U.S. tax responsibilities. If the U.S. LLC you establish is owned by you personally, you will need to obtain an ITIN number (Individual Taxpayer Identification Number). This is equivalent to a U.S. SSN (social security number) for tax purposes.
U.S. Tax Responsibilities
All foreign investors owning U.S real property are responsible for paying taxes on any and all rental income they earn in the United States from that property.
There are several factors involved to determine your U.S. tax rates on your rental income. Those include; the 30% withholding tax, is the foreign person considered to be engaged in a U.S. trade or business (or is the income considered effectively connected income, are you a passive investor, do you elect to have your passive income taxed as if effectively connected to remove the withholding obligation…
These tax rules become complex and require a competent U.S. CPA or law firm that understands both real estate and foreign investors.
How to Obtain an ITIN and EIN
Obtaining an ITIN number may take 6-12 weeks through the IRS. Typically, to close on the real estate transaction, you will need to have your entity set up with your U.S. bank account and U.S. address. The entity’s EIN is obtained from the IRS by fax (with a US entity) even with no social security number). The bank will need the EIN, filed articles, operating agreement, and individual signer information to get started.
How to Open a U.S. Bank Account
You will need to travel to the U.S. to open a business bank account under the LLC’s name. Even with travel, most banks now require a personal utility bill for the owners, which creates a real issue if you don’t live in the U.S. or have a personal address (non-PO box). The good news is my company, NCP, has a resource when you travel to Las Vegas and a service to guide you through the process without a personal U.S. utility bill.
Update: We do have a non-travel option to establish a U.S. bank account for a U.S. entity. Learn more here.
A U.S. address is important for all U.S. correspondence on your real estate, items from the IRS, the escrow company, and your property management company…It helps to have a legitimate virtual address attached to a physical address vs. a PO box.
Now that you have a U.S. company, you also have to be aware of the U.S. immigration laws when you come to the U.S. to visit. Don’t make the mistake of saying you are coming to the U.S. for your U.S. company when you are really coming to a seminar and visiting (that will lead to big problems at the U.S. border).
If you are looking to get a VISA to come to the U.S. to work with NCP, you will receive a complete step-by-step webinar with a top U.S. immigration firm that explains the steps and rules for you to avoid issues at the U.S. borders.
Overall, investing in U.S. real estate is a great opportunity. The key is to work with a company like NCP (our vetted referral partner team of legal and tax experts), who can provide you with the steps, resources, and tax and legal support tools to make this a turnkey experience for you.
Real Estate FAQs
Q: How do I protect my real estate investments?
A: Many of our real estate investor clients form an LLC to hold and manage their real estate to protect their other assets from liabilities or lawsuits that might result from their real estate investment.
If an LLC is formed and managed correctly and there is a claim or lawsuit relating to the real estate, then generally, only the assets owned by the LLC, and not the investor’s other personal assets, will be subject to the claim or lawsuit.
The reason being, if you own 2-3 properties outside of your residence, you are a target for a lawsuit, even if you have no equity. Many have lost everything financially and will be looking for alternatives, and lawsuits can be a financial game plan.
Even with no equity, you may have an insurance policy they can collect from. That is a big part of the problem. I will point out that your home (or principal residence) is handled differently.
With that being said, here are the strategies and key points to consider for protecting real estate when transferring it to an LLC.
Keep in mind, almost always, when you purchase a rental property, for example, you will be closing escrow in your name personally, with a personal guarantee. You would typically transfer it to the LLC after the close of escrow, via quitclaim or warranty deed.
Here are some issues to be aware of when you do that.
Four Key points to be aware of when you own real estate and are considering forming an LLC to transfer the property into the LLC (called quitclaim or warranty deed). Typically, a title company would do this for you.
- Due on Sales Clause: Your mortgage company can accelerate your loan if you change the title. When you purchase the property in your own name and then transfer it to an LLC (a different name), the mortgage company can technically call it a mortgage and make you pay off the mortgage.
This really never happens, as long as you continue to make the mortgage payment from the LLC, and the owners are the same, meaning you and your wife owned it before, and now you and your wife are the LLC members. Plus, most mortgage companies resell their mortgages.
- Transfer tax: the county assessor may charge you a transfer tax for transferring the property (from you to the LLC).
Usually, there is an exception if you (or you and your spouse) own 100% of the property before and after the transfer. In that case, there is NO tax. If you change the title and add a new owner to the LLC, that MAY trigger a tax.
If you are not getting the response you want from the county assessor, you can use this approach; The best way to test this is to ask, “is there a transfer tax if we transfer it to our living trust?”
When the country assessor says, “No, that is an exception,” you can say, “now that we have established that there are exceptions, are there other ones?
- Reassessment for property tax purposes-if someone has held onto the property for many years, transferring it may trigger a reassessment for property taxes.
The local county will tell you if that is the case. Many times, areas automatically reassess every few years, and this is not a real concern.
The exception is California (Prop 13), where the values have been frozen for many years, and transferring property could trigger a huge reassessment for property tax purposes.
- Insurance issues: When you go from owning a property in your own name to transferring it into an LLC, the insurance company may charge a higher insurance rate (with more coverage) for you, as a landlord, because they now look at you as a business.
Sometimes, the increase may be minor, like $100 per year. The key is to make sure you communicate to your insurance company, so if you have a future claim, you do not give them a reason to refuse to write you a check!
If the insurance policy was made out to you because you owned the property, and now you have transferred it to an LLC, but the insurance policy is not in the LLC’s name, is that a problem from the insurance companies’ point of view?
That is what you must find out!
Protect Your U.S. Real Estate with a Separate LLC for Each Property? It Depends
The next step is to determine how many entities for your properties. The key is not to put all your “real estate eggs” into one basket. Meaning, do not just form one LLC to hold five properties representing 90% of your net worth.
If the LLC is sued directly by a tenant and you lose, and your insurance company does not pick up the tab, you may lose 100% of your equity in that one LLC!
That also does not mean you need five separate LLCs for each property. The factors you want to take into consideration are the following:
- The fair market value of each property.
- The equity in each property.
- The percentage of overall net worth the real estate represents.
- The liability of each property.
Example: if you have two rental properties in Northern Wisconsin that are only $80,000 each, with $30,000 of equity, but this only represents 30% of your net worth, then one LLC is probably fine for both properties. Again, everyone’s risk tolerance is different.
If you have two properties in California worth $1.5 million each, with $500K of equity and that represented 90% of your net worth, you would want two LLC’s (even with the $800 California franchise tax on each LLC).
Finally, when you form an LLC, you must have a complete formation, not one of those “get you in the door” cheap LLC package that only files articles and provides an EIN.
If you are involved in litigation, you will want to make sure you have a complete formation if you want to protect your equity.
Go to this link to find out more details on what is involved in a complete formation. Take the correct steps to protect your equity and family’s financial future.