Martin Jajan, Founder and Managing partner at Jajan and Associates located in the Financial District, has helped hundreds of foreign national buyers purchase property in the United States. Our team asked him to share with us some of the challenges they face and some of the solutions he offers.
The Buying Process
The foreign buyer isn’t always aware of the complexity of a real estate transaction in the United States. Many European and Latin American nations tend to be “civil law countries” in which transactions are done through what their concept of a notary is. In the United States, a notary has the power to authenticate a signature, but in civil law countries the state grants a notary the authority to supervise an entire real estate transaction. So foreign buyers are often surprised that they need a lawyer, and that a separate attorney would represent the seller and a lender in instances when the buyer is financing a property.
The foreign buyer is often unfamiliar with the need for title insurance as well, according to Jajan. “In foreign countries, if there is a mistake with chain of title, it’s on the notary,” he said. “There isn’t a separate title company that is insuring title. There is no title insurance.”
Strategies and Structures
Jajan’s first conversation with a foreign buyer always begins with a description of the American buying process, but before long the dialogue shifts more specifically toward the tax implications of the purchase, and in many instances toward privacy and maintaining anonymity.
“The foreign buyer is not going to be taxed the same way that U.S. people are going to be taxed,” Jajan said. “The IRS code is clear that they will tax foreigners that are investing in property in the United State vastly different than they would U.S. citizens.”
The inheritance tax is most commonly the primary tax consideration when deciding upon how to structure a transaction. The exemption for U.S. citizens is $11.5 Million, and it’s doubled for a married couple. Foreigners are only given a $60,000 exemption. So, if a U.S. citizen passes away, their heirs could inherit up to $11.5 Million in assets free and clear of any tax. But a foreigner would pay tax against an inheritance in excess of $60,000. The amount of that tax tends to fluctuate between 35% and 45%.
Hundreds of documents have been written on how to avoid the estate tax, but Jajan says he can distill the information and deliver it in a conversation that lasts about 20 minutes. From there, based on his clients’ circumstances, he can make a recommendation that will quickly and effectively protect them from the estate tax in a relatively inexpensive manner.
Jajan estimated that 90% of his foreign clients form an entity of some kind and the entity created ultimately is the buyer in the transaction. He identified three common strategies.
- Form an LLC.
The Limited Liability Company (LLC) acts as a pass-through entity that will provide his clients with a higher level of anonymity and they would also gain some tax advantages compared to buying as an individual. Forming a simple LLC, however, will not protect the property owner or members of the LLC from the estate tax.
- Form an LLC that is taxed as a corporation and is linked to an off-shore corporation.
This multi-faceted structure would protect a foreign buyer from the estate tax. The estate tax is not imposed upon the death of the owner of an offshore corporation because the asset itself is not within the United States, and therefore falls outside the government’s jurisdiction.
With this structure, the owner would be subject to higher capital gains taxes compared to the first structure.
- Form a Trust
Forming an Irrevocable trust is a common solution for foreign buyers that are making a purchase in excess of $5 Million, because it can offer a client the best of both worlds according to Jajan.
The trust would own an LLC and the LLC would own the property being purchased. The trust would be taxed at a lower rate compared to an individual, and, because the trust will never die and continue in perpetuity, an estate tax would never be imposed.
** Some of the suggested structures can present an issue for lenders. So, Jajan always asks if his client plans to finance the purchase or pay cash. He’s met with multiple lenders that specialize in situations like these and are often more flexible and more amenable to starting a relationship with a foreign national.
Ideal NYC Property Type for the Foreign Buyer
For many foreigners, privacy is paramount. Structuring in any one of the methods that Jajan suggests would certainly provide a high level of privacy from the public. But buyers purchasing a co-op, or an existing condominium will be asked to disclose significant personal financial information.
Very rarely is the foreign buyer trying to hide anything, Jajan said. “From a cultural perspective, it’s very invasive to have to give financial disclosure information, when the fact is, that’s not what’s done in their home country.”
A foreign buyer purchasing a pied-a-terre, or an investment property is usually someone of means, and in some cultures, they’re used to a very high level of service and they’re used to people wanting to do business with them.
“The idea that they have to provide tons of financial disclosures and go on a co-op interview and beg someone to take their money and let them into their building doesn’t sit well with them,” Jajan said. “It’s offensive.”
Perhaps more importantly, in some instances the disclosure of financial information can bring with it a security threat.
“People hold their cards very close to their vest in terms of what their assets are and how they made their money,” Jajan said. “If this information falls into the wrong hands, that’s when kidnappings occur. That’s when other crimes and security risks might occur.”
The Ideal Property Type for a Foreign National Buyer
A new construction condominium is the ideal property type for a foreign buyer that wants to avoid disclosing personal information. A new project likely hasn’t assembled a board and the developer/sponsor has the right to sell without commanding a board package, so there is no financial disclosure involved (outside of what a lender would ask for in a situation where financing is involved).
Although an existing condominium has no ability to approve or decline someone who wants to buy in a building (like a co-op board does), a board has the ability to waive the right of first refusal or to exercise it. They often use that ability as leverage to collect a full board package from a potential buyer.
Many condominiums include in their by-laws a right of first refusal, which would force an owner to offer their unit back to the condo before selling to a third party. It’s important to note that a title company won’t issue a title policy unless the condominium waives their right of first refusal, and most lenders won’t issue a mortgage unless that right is waived. Its not unusual for a condo board to have concerns with absentee owners living overseas because it might be more difficult to collect common charges and/or special assessments. They’re also cognizant of their owner occupancy levels in an attempt to remain compliant with lender guidelines.
“They are using their power to get as much information on someone as possible so they can make a decision on how to protect themselves,” Jajan said.