Pre-Immigration Tax Planning, Part III: Remedying The Adverse Consequences of the Covered Expatriate Regime

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INTRODUCTION

Following our previous articles regarding pre-immigration planning and the expatriation rules applicable to covered expatriates (see here and here), this article considers some techniques for implementation before and after expatriation, with the objective to reduce the adverse treatment of the covered expatriate regime to the extent possible depending on the specific facts and circumstances of each individual.

For a Green Card holder, expatriating prior to becoming a long-term resident would eliminate the application of the covered expatriate regime. For a U.S. citizen (other than children under certain situations), the circumstances that will allow for a tax-free expatriation are more restrictive. An individual is considered a covered expatriate if he or she meets one of three tests. Pre-expatriation planning can eliminate the application of the covered expatriate regime for some individuals, while for others additional planning may be needed to reduce the unfavorable effect of the covered expatriate rules.

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property – Part III

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INTRODUCTION

This is the final article in a three-part series that explains U.S. taxation under the Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”). This article looks at certain planning options available to taxpayers and the tax consequences of each.

These planning structures aim to mitigate taxation by addressing several different taxable areas of the transaction. They work to avoid gift and estate taxes, and double taxation of cross-border events and corporate earnings, while simultaneously striving for preferential treatment (e.g., long-term capital gains treatment), as well as limiting over-withholding, contact with the U.S. tax system, and liability. Often, such structures are helpful in facilitating inter-family transfers and preserving the confidentiality of the persons involved.

PRE-PLANNING

As with everything else, planning can go a long way when it comes to maximizing U.S. real estate investments. Here are a few questions to ask:

Investor Background

1. Where is the investor located?
2. Where is the investment located?
3. What kind of business is the investor engaged in?

Tax 101: Understanding U.S. Taxation of Foreign Investment in Real Property - Part II

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This article examines the U.S. income, gift, and estate tax consequences to a foreign owner upon a sale or other disposition of U.S. real property, including a sale of real estate, sale of stock of a U.S. corporation, or a sale of a mortgage secured by U.S. real property.

In addition to (or sometimes in lieu of) rental income, many foreign investors hope to realize gain upon a disposition of U.S. real property. The Foreign Investment in Real Property Tax Act of 1980 (“F.I.R.P.T.A.”) dictates how gains are taxed from the disposition of United States Real Property Interests (“U.S.R.P.I.’s”). The law has a fairly extensive definition of U.S. real property for this purpose. Most significantly, the law provides for a withholding mechanism in most cases.

WHAT IS A U.S.R.P.I.?

A U.S.R.P.I. includes the following:

• Land, buildings, and other improvements;
• Growing crops and timber, mines, wells, and other natural deposits (but not severed or extracted products of the land);
• Tangible personal property associated with the use, improvement, and operation of real property such as:
• Mining equipment used to extract deposits from the ground,
• Farm machinery and draft animals on a farm,
• Equipment used in the growing and cutting of timber,
• Equipment used to prepare land and carry out construction, and
• Furniture in lodging facilities and offices.
• Direct or indirect rights to share in appreciation in value, gross or net proceeds, or profits from real property;
• Ownership interests other than an interest solely as a creditor, including:
• Fee ownership;
• Co-ownership;
• Leasehold interest in real property;
• Time-sharing interest;
• Life estate, remainder, or reversionary interest; and
• Options, contracts, or rights of first refusal.

Recapitalization of L.L.C. Interests and Issuance of Profit Interests Held to be Gifts in Estate Freeze

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Code §2701 is a provision which renders the transfer of a partnership or membership interest to a family member a gift. The tax typically applies in an “estate freeze” scenario, where one generation attempts to transfer assets which appreciate in value to another generation, thereby removing it from their estate for estate tax purposes. In its latest Chief Counsel Advice (“C.C.A.”), the I.R.S. held that a recapitalization of a limited liability company (“L.L.C.”) triggers a gift under Code §2701 in a case where a mother retained a right of distribution but transferred the gain or loss attributable to the L.L.C.’s assets to her sons. The I.R.S. held that the interest retained by the transferor (a distribution right on the existing capital account balance) was a senior interest, whereas the transferred interest held by the sons (the right to future gain of the L.L.C.’s assets) was found to be a subordinate interest. What is notable and most troubling here is that the interests transferred to the sons are so-called “profits interests,” issued for future services to be rendered to the L.L.C.

IN GENERAL

Code §2701 imposes special gift tax valuation rules when partnership or membership interests are transferred to family members. Family members covered under Code §2701 include the spouse of the transferor, any lineal descendant of the transferor or the transferor's spouse, and the spouse of any such descendant. In general, Code §2701 devalues interests of senior family members in order to increase the value of interests transferred to junior family members. Code §2701 generally applies to situations where the transferor retains a senior interest and transfers a subordinate interest to the transferee – such as when a parent keeps preferred shares and transfers common shares to family members.