U.S. REPORTING REGULATIONS FOR FOREIGN OWNERS
There are very few restrictions on ownership of U.S. property by foreign persons, but your clients should be aware of certain reporting regulations.
The Agricultural Foreign Investment Disclosure Act requires the reporting to the Farm Service Agency of the Secretary of Agriculture2 within 90 days of a transfer to or from a foreign person if the land has been used for agriculture, forestry, timber, farming, or ranching, within the last five years, is 10 acres or more, and generates $1,000 or more in gross receipts. Failure to make a timely report can generate hefty penalties.
The Bureau of Economic Analysis of the Commerce Department3 requires reporting of foreign ownership of all real property for analytical and statistical purposes only. There are exceptions for a personal use primary residence (or rental if intent to return) and partial exemption from reporting for real estate which is both valued at less than $3 million and is less than 200 acres.
U.S. TAX REQUIREMENTS
1. CAPITAL GAINS TAX ON SALES
Non-resident aliens and foreign corporations are taxed on income resulting from the sale of U.S. real property. A buyer who is aware of that at the time of purchase can plan accordingly, and may even consider an exchange. The time to divest can become the time to reinvest.
2. FIRPTA (FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT)
Under FIRPTA, a buyer must withhold 10% of purchase price if the seller is a foreign person. No withholding is required if the seller is a U.S. citizen; green cardholder (lawful resident); or resident alien (meets either the physical presence test—present in the U.S. for at least 183 days in the current calendar year; or the substantial presence test—present in the U.S. for a weighted average of 183 days over three years).
At the time of purchase, inform your foreign buyers that they must acquire a U.S. taxpayer identification number (TIN). Waiting until the time of sale to obtain a TIN may cause difficulty recovering money withheld pursuant to FIRPTA.
3. INCOME TAX (ON INCOME PRODUCING PROPERTY)
Generally, non-resident aliens are taxed at a flat 30% federal tax rate on gross rental income, unless they make a certain income election on their returns. This election, which allows for deductions for regular expenses before income tax is calculated is commonly know as the “net election.” Your client who is interested in income properties should ask any potential tax advisor (lawyer or accountant) if the advisor knows about, and how to exercise, the “net election.” Further, anyone who collects income for a non-resident alien and then pays that income to a client is generally required to withhold 30% of gross U.S. source income (such as rent). No withholding is required if the foreign person has a green card, meets the physical or substantial presence test, or if there is a treaty addressing this issue between the U.S. and that person’s home country.
4. PROPERTY TAXES
Property tax payments are required as an additional cost of real property ownership. These payments can be added to a loan or paid directly to the taxing agency. Failure to pay property taxes can lead to financial penalties and even loss of the property. Just as a taxing agency (usually a county) has remedies against a property owner for failure to pay property taxes, so may a lender, since the failure to pay usually is also deemed a breach of the loan agreement. It is important to know that change in ownership, such as altering title among family members and differing entities may cause the property value to be reassessed, and the property tax payments to increase.
5. TITLE DECISIONS
The way your foreign buyer clients take title (individual, foreign corporation, U.S. corporation, or trust, for example) is a serious decision that could affect their ability to transfer the property and the financial and tax implications both during the property’s ownership, and upon sale. In states like California, which taxes worldwide income, the decision can affect more than the property itself. Since the method of holding title can affect the tax consequences during life and after death, it is advisable to advise your clients to seek out a competent lawyer or an accountant with an international practice.
IMMIGRATION AND NATIONAL SECURITY LAW
You should know the difference and effect of your clients’ residency status on property ownership. If your clients are in the U.S., or intend to visit before or at the close of escrow of a property, you should know whether they have a visa (and the type—for example, work or student), a green card, or neither; and if they have or intend to get a U.S. taxpayer identification number. Also, the U.S. government places restrictions on the ability to do business with certain individuals. The Office of Foreign Asset Control4 may be involved if your client’s name appears on, or is even similar to that on, a specially designated persons list. Don’t let your client be surprised or offended; be prepared.
The practice of selling real estate varies from country to country. Your clients’ expectation of what a real estate agent can and should do may not be consistent with what is allowed and standard in your area. In most U.S. states, a real estate agent has the authority to receive and present offers but not the authority to sign for the principal without a power of attorney. In other words, the agent can negotiate on behalf of, but not bind contractually, the principal.
Further, the Statute of Frauds and Equal Dignities Rules, laws common in the U.S., provide that if an agent has been given actual authority to enter into a contract on behalf of the principal, the agent’s authority must be in writing in order to be enforceable. If your foreign buyers have experience in other U.S. states, ask what their experience with agency has been. In some states, the licensee acts as a facilitator, and not an agent. You may have to clarify differences, not only between the foreign country and your state, but also between your state and another state.
Finally, if dual agency is permitted in your state, be certain that your principals understand the difference between single agency and dual agency, If your firm engages in dual agency, notify your clients of this in writing.
CONTRACTS AND CONDUCTING NEGOTIATIONS
In states where it applies, the Statute of Frauds requires that a contract to sell real estate must be in writing and signed by the party to be charged if it is to be enforceable. Verbal agreements to sell are not binding nor are agreements that are signed by the principal’s real estate agent instead of the principal (unless the agent has a written power of attorney from the principal). An indication that the agent spoke to the principal and the principal approved (such as adding the words, “per telephone conversation”) does not make the contract enforceable.
The primary negotiation between buyer and seller typically occurs before a contract is signed and a purchase price agreed upon, but the contract might effectively create additional negotiating points—for example, following a buyer’s inspection of the property or before the buyer removes certain contingencies. Persons not familiar with the process and contract requirements in your state may believe either that no further negotiation is expected or required or, conversely, that everything is negotiable right up to payment of the purchase price. While market forces ultimately will determine who gets what and when, your client’s expectation of the contract and negotiating process should be checked against what is the legal, contractual, and the standard of practice in your community.
ESCROW AND THE CLOSING PROCESS
In the U.S., the escrow process is formalized with different parties serving different roles. The escrow holder serves as a neutral depository for documents and money with equal duties to buyers and sellers plus responsibilities to existing and future lenders. The escrow holder performs these services for a fee. If the transaction does not go forward and the escrow holder holds the buyer’s deposit money, generally the funds will not be released without mutual signed instructions from both buyer and seller. While some buyers may not be comfortable with this procedure, the alternative of releasing deposit money direct to the seller may be even less appealing. As with other contract terms, the choice of escrow holder is negotiable but if the escrow holder and title company are one and the same in your area, the Real Estate Settlement Procedure Act (RESPA) may restrict the seller’s ability to require the buyer to use a particular entity if the buyer will be paying for all or some portion of the title insurance.
THE DISPUTE RESOLUTION SYSTEM
The way problems in a real estate transaction are solved may be very different from the system in the buyer’s native country. Misconceptions may need to be addressed.
The first step in resolving a dispute should always be to try to negotiate a solution that is satisfactory to all. After that, the contract or the law may require the buyer and seller to attempt to mediate a resolution with the help of a third party neutral mediator. Explaining to your clients that mediators do not have the authority to force a resolution on the parties may help achieve their appreciation for and involvement in the process and achieve a successful mediation. If these efforts fail to resolve the dispute, the legal system may be the next step. In many countries government involvement is something to be avoided because of corruption, inefficiency, or unfairness. As a result, some foreign clients may be frightened or suspicious of the legal system.
On the other hand, some foreign clients may have idealized expectations of the legal system in the U.S. They may need to be educated that the U. S. legal system is generally fair, though often time consuming and expensive, and that it is public. Anyone who wants to attend the hearing may do so and the verdict is open to the public. Also, receiving a favorable judgment at trial and collecting on that judgment are two entirely different things. First, the losing party may appeal. Second, the losing party may not be able to pay or have any assets worth pursuing. And third, bankruptcy may be filed to stall or avoid a judgment altogether. For the buyer who is purchasing rental property, or may consider converting a personal use residence to rental property at some time, a reminder that tenants have legal rights and in locales where rent control laws are present these rights can be substantial.
An alternative to the legal system is arbitration. The use of arbitration in lieu of court is by agreement of the parties. Advantages of arbitration over litigation is that it is private, the result is typically binding, the matter can often be resolved sooner than going to court, and the parties determine who will decide their dispute—they get to select the arbitrator. Disadvantages to arbitration include the loss of the right to have a jury hear your case, the lack of any appeal right, and the obligation to pay the arbitrator and the administrator, if there is one.
In the U.S., sellers typically pay a real estate licensee to market their property. This agreement to pay is usually required in writing. A buyer’s agent typically receives payment from the seller or from the listing agent. Increasingly, it is common for buyer’s agents to have buyers sign agreements as well. These agreements can provide for the buyer to pay the broker, and may or may not credit the buyer for all or part of the compensation the buyer’s agent receives from the seller or seller’s agent. As practices vary widely throughout the world, it is important to ask your clients what their expectations are, and then be prepared to explain why your compensation model is legally required or beneficial for them, when compensation is expected, and the effect, if any, on agency relationships. Sometimes, buyers can expect that someone they know will be compensated by you because of a referral, involvement in the transaction, or simply because that person has a real estate license. Determining this early allows you to explain your policy, and explore allowable and legally permissible compensation arrangements.
It is quite possible that some foreign clients will be unfamiliar with the concept of seller disclosure because their home country operates on the basis commonly referred to as “buyer beware.” A buyer who is aware of seller disclosure laws in your state may confuse seller disclosure with seller warranty or seller guarantee. It is important to educate your clients about what disclosure requirements are imposed via the contract, common law, or legislation, and about the effect these requirements have on the buyer’s duty to use due diligence.
Since the world is becoming smaller all the time, your representation of foreign buyers of U.S. real property will only increase in the future. While some issues differ significantly from those you are used to addressing with U.S. clients, many are the same. Regardless, it is important to understand your client’s expectations and be able to bring relevant information to your client’s attention. You don’t have to know everything about all cultures worldwide—just those that affect your client. There are plenty of places to get help. As a member of the CIPS Network, you may want to start by calling upon one of your fellow CIPS who has the expertise you’re seeking. Check out the CIPS Web site at www.realtors.org/international. It has a vast amount of information and resources.
Published by the CIPS Network of the National Association of REALTORS®
Fourth Quarter 2005
The Basics of Representing Foreign Buyers in the U.S. By Neil Kalin, Esq.