REAL ESTATE: Impact on Tax for Property Investors during COVID

During 2020 the Chancellor announced a Stamp Duty Land Tax holiday to encourage fluidity in the UK property market. With low interest rates and tax cuts to encourage buyers we saw a large increase in the amount of lending and home purchases through out 2020. Despite this the temporary tax breaks the UK still has quite an unfavourable tax regime for the average real estate investor and some may be considering investing overseas in other countries such as the USA. For many, the USA continues to be a very popular country to invest in real estate and the regulations on non-resident investors are much more relaxed in comparison to the UK. We take a look at what an investor can expect from a tax point when investing in US real estate and discuss how this will impact a UK investor holding foreign property.

Currently in the UK rental property income is taxed as non-savings income and subject to rates of 20%, 40% and 45% (Different rates apply for Devolved Governments). For UK residents this income is reduced by your personal allowance but for non-resident property investors a personal allowance may not be applicable meaning the entire profit from UK rental property is taxable. Couple this with the recent abolishment of a deduction for mortgage interest and the tax due has increased.

Not only this but typically the purchase of a property is taxed on it’s value where a property valued at more than £500,000 will be subject to a Stamp Duty Land Tax of 15% (additional 1% surcharge for non-resident investors). This of course has been temporarily waived as part of the UK government’s COVID relief plan but will eventually expire. Selling a UK rental property will see a capital gains tax due at 18% or 28% depending on which income tax rate a person falls into. Of course exemptions from capital gains tax are available but year on year these exemptions are being reduced and could be abolished entirely. Not to mention too much about the potential for a capital gains tax increase in the coming years.

We also need to consider the time limit with which a capital gain s to be reported to HMRC following the sale of rental real estate and the payment of tax. AS of 6April 2020 gains on UK real estate sold much be reported within 30 days of the completion of the sale and capital gains tax paid.

If this applies to you find out how you can stay compliant with your reporting and tax obligations on the HMRC website.

Historically the US real estate market has always been very friendly to foreign investors and a lot of the restrictions found in other countries doesn’t exist. Tax laws applicable to non-US residents investing in US real estate it is very similar to that which applies to a US person. Income tax and capital gains tax are charged on income or disposals of real estate located in the US. mortgage interest is fully deductible and depreciation is allowed on the capital cost of the property.

BUYERS BEWARE: The IRS launches action campaigns and targets certain areas of international tax non-compliance and the targeting of non-resident foreign investors in US real estate is one of those campaigns as of October 5, 2020. it’s may come as no surprise that there are withholding regulations in place to make sure that non-resident investors pay their tax to the US Treasury where there is taxable income and gains for US real estate.

Note at this point that a rental income and the gain on the disposal of US real estate is ALWAYS considered US sourced income regardless of the taxpayer’s personal status or the existence of a Tax Treaty application in the Treaty Resident’s home country.

There are two ways real estate can be taxed by a foreign investor in the USA:

1. Taxed at a flat 30% withholding tax on the gross income without regard to expenses and deductions.
2. Taxed as a US Trade or Business at graduated rates on the net income after applicable expenses and deductions.

The tax rate which applies depends on the activity itself and whether this can be considered a US trade or business or simply passive investment income to the investor.

Where the real estate income is passive and subject to a 30% withholding, a timely s.871(d) election filed with a tax return can be made to treat the passive activity as a US trade or business in order to claim those deductions and credits that would otherwise not be allowed. The end result being that tax is imposed on the net profits rather than the gross income.

In addition to withholding on income there is also withholding gains from the disposal of real estate in accordance with the Foreign Investment in Real Estate Property Tax Act (FIRPTA). Persons buying US real estate from a foreign non-US person must withhold tax on the amount realized in the disposition. The current withholding rate is 15% and s calculated based on what the foreign person realizes as a gain on the sale. The rules for foreign corporations buying and selling US real estate are different and of course there are exceptions which we will cover in more detail in another article dedicated to discussing the FIRPTA rules.

If you plan on buying real estate in the UK or in the US or any other country for that matter, definitely seek out an adviser who is knowledgeable in the taxation of real estate as there are many consideration that we have barely touched on in this article such as tax residency, double taxation, domicile and inheritance tax.