By Kristie Parker, Esq.
I was recently watching a TV series where “regular Americans” were searching for their dream property…in Honduras. More and more frequently we hear from clients who want to purchase real estate in a foreign country. Because there are over 195 countries in the world today, each deal will have its own specific considerations. However, there are still common issues and tasks to consider when purchasing real estate outside of the United States.
Finding a Property
You should treat purchasing a property in a foreign country like making a long-term relationship commitment. You need to get to know the place before you go all in. You should stay in a prospective location long enough to get familiar with the area, the expat community (if any), and local customs. Finding and meeting a local real estate agent during your visit(s) can make purchasing from afar significantly easier later on. In addition, visiting your potential location can help you learn the market and evaluate whether you are getting a “good deal”. The good news is that you have an excuse to pack your bags for your “research” trip.
Recently, large U.S. real estate brokerages have established local branches in popular foreign destinations (e.g. Coldwell Banker International) that can help you find the right existing property. Of course, if you can’t find the right property, you might consider building your perfect home as an option. However, be very cautious if you plan to build in a foreign country, as there are numerous examples where a hefty deposit is paid, but the developer runs out of funds for the project. This usually results in the house never being built (or it is significantly delayed). Make sure to tie any payments to project completion targets. Again, do your research to make sure you are using reputable contractors that have reasonable expectations. In some locations, taking several years to build may be the norm. Finally, buying in a managed community may help protect against theft, general maintenance issues, and natural disasters.
Identifing Foreign Ownership Rules
Many countries have specific limitations on foreign ownership of land. For example, in Mexico there are limitations on foreign ownership of property within 31 miles of the coast. In American Samoa, a U.S. territory, it is prohibited for any person who is less than one-half Samoan to own land. In a situation like that, you might want to look at getting a long-term lease instead of actual ownership. In other jurisdictions non-citizens may be required to obtain special residence permits or register with a government agency prior to closing a home purchase. In Spain, you need to invest €500,000 in real estate to qualify for an investor residence permit. Again, a local real estate agent or attorney may be your best resource for identifying these critical rules. The U.S. Embassy in your host country may also be a resource for local laws regarding purchase of foreign property. In many cases, owning real property in a foreign corporation or land trust may be more advantageous than owning it individually. However, contact your U.S. tax advisor about the effect of any foreign corporation on qualifying for income exclusions on gains at sale.
Understand Your Financing Options
One of the more difficult hurdles of purchasing real estate in a foreign country is financing the purchase. Generally, most U.S. banks won’t lend for the purchase of real estate abroad. Consequently, many foreign investors choose to use cash to purchase foreign property. You may access cash by taking out equity on your primary residence in the US, through personal loans, or your savings. In some cases, you may be able to obtain a mortgage through a foreign bank, but they often will take some time to set-up, will require a significant down payment, and can carry a high interest rate. Finally, seller financing may be an option, just be sure that your seller has the right to transfer the property to you. Another potential cost to be aware of when you are getting your funds together is the transfer fee or stamp duty tax imposed by many countries that may add 10% or more to your purchase price. When you transfer significant sums of money for a down payment or purchase price, pay attention to foreign exchange rates and fees associated with the transfer, as those can add up as well. You can get good deals in many locations, but make sure to include all of the costs of purchase.
Ensure Compliance with U.S. Tax Rules
The last piece of foreign property ownership is accounting for any income or gain you may accrue due to the property. As a U.S. citizen, you are required to report to the IRS on your worldwide transactions. In addition, the FATCA regulations have added to the reporting requirements for foreign held assets. Further, there are penalties starting at $10,000 for failing to file the proper tax forms. If you have a bank account outside of the U.S., you will need to report it on Schedule B of your Form 1040. In addition, if the foreign account exceeds $10,000 at any time during a calendar year, you will also have to file a Report of Foreign Bank and Financial Accounts (FBAR-Form 114).
If you own your property with a corporation, you should pay particular attention to reporting requirements. You will file a Form 5471 as the owner of a Controlled Foreign Corporation (CFC). Further, as of 2011, FATCA regulations may require you to file a Statement of Foreign Financial Assets (Form 8938) if your foreign assets exceed certain reporting thresholds.
If you own a foreign rental property directly, you will be required to report the rental income on your personal income tax return. However, you can deduct mortgage interest and local property taxes from your individual 1040. Similarly, if you sell the property for a gain, you may pay taxes in the foreign country, and it is reportable income on your U.S. individual tax return (Schedule D). In this case, the foreign tax credit may help offset some or all of the U.S. tax on the gain. If you live in the foreign residence for two years out of five prior to the sale, you may be eligible to exclude any gain on the sale of the property from your income (up to $250,000 if you are single, or $500,000 if you are married). If you do not meet the 2 out of 5 rule, the gain will be taxed at capital gain rates. Gains from the sale of foreign property are considered foreign source income and may be reduced by the foreign tax credit.
If you find yourself watching Giligan & Gidget with envy, buying foreign real estate just might be for you! Foreign real estate can be a smart investment – as long as you do your due diligence up front, consult experienced advisors, and keep good records as you go.