US Investment Taxation for Non-Resident Foreign Investors

Income Tax on Rental Revenue

When earning rental income from U.S. real estate, a non-resident foreign investor must utilize one of two distinct tax regimes.

The default classification falls under the Fixed, Determinable, Annual, or Periodical (FDAP) income rules. Under FDAP, gross rental payments are treated as passive investment income. A flat 30% withholding tax is levied on the total rent collected. This regime prohibits any expense deductions. Investors cannot offset gross revenue with mortgage interest, property management fees, maintenance costs, or local property taxes.

Alternatively, an investor may make a formal election under Internal Revenue Code Section 871(d) to treat rental income as Effectively Connected Income (ECI) with a U.S. trade or business. Under ECI, net rental income is taxed at graduated individual rates (ranging from 10% to 37%) or at the flat 21% corporate rate. This election allows investors to deduct ordinary and necessary operating expenses, mortgage interest, property taxes, and asset depreciation. For residential real property, the building structure (excluding land value) is depreciated over a 27.5-year recovery period using the straight-line method, which often offsets net taxable income during operational years.

Real Estate Dispositions and FIRPTA

The sale or transfer of U.S. real property by a foreign person is governed by the Foreign Investment in Real Property Tax Act (FIRPTA). FIRPTA serves as a tax collection mechanism rather than a final tax liability.

Under FIRPTA, the buyer acts as the withholding agent and is required to withhold 15% of the gross purchase price at closing, remitting these funds directly to the IRS. This 15% withholding is assessed on the total sales price rather than the net capital gain realized by the seller.

The seller determines their actual tax liability after the close of the tax year by filing Form 1040-NR. Long-term capital gains (assets held for more than one year) are taxed at rates up to 20%, depending on income thresholds. Unrecaptured Section 1250 gain—representing prior depreciation deductions taken against rental income—is taxed at a maximum rate of 25%. If the 15% gross FIRPTA withholding exceeds the seller's actual tax obligation, the excess amount is refunded upon processing the return.

Annual Local Property Taxes

The U.S. federal government does not levy a national real estate ownership tax. Real property taxes are assessed and collected exclusively at the state, county, and municipal levels.

Property tax rates vary by jurisdiction, generally ranging from 0.3% to 2.5% of the property's assessed value per year. Tax rates apply equally to domestic property owners, U.S. residents, and non-resident foreign investors. Payment of local property taxes is mandatory regardless of whether the asset generates rental revenue or remains vacant.

Federal Estate and Gift Tax Exposure

Estate tax exposure represents a primary risk factor for foreign investors holding U.S.-situs assets directly in their individual names.

While U.S. citizens and domiciliaries benefit from a substantial lifetime estate tax exemption, the exemption threshold for non-resident aliens is capped at $60,000 for U.S.-situs property. Gross estate value exceeding $60,000 is subject to federal estate tax rates up to 40%. U.S. real estate owned directly by an NRA is classified as U.S.-situs property and subject to this tax upon the owner's death.

Structuring and Holding Ownership Models

Foreign investors utilize various corporate and legal structures to limit estate tax exposure, manage FIRPTA requirements, and mitigate personal legal liability.

Direct individual ownership permits deductions under an ECI election but leaves the owner exposed to personal liability and the $60,000 estate tax threshold.

Holding property through a domestic Single-Member Limited Liability Company (LLC) provides legal asset protection. However, for federal tax purposes, a single-member LLC is generally treated as a disregarded entity. As a result, tax liabilities flow through to the individual owner, maintaining direct exposure to the U.S. estate tax.

Ownership through a domestic C-Corporation subjects income to the federal corporate tax rate of 21%. While holding property inside a U.S. corporation eliminates direct FIRPTA withholding on the foreign shareholder upon asset sale, the shares of the domestic corporation remain subject to U.S. estate tax rules.

A two-tiered holding structure—comprising an offshore foreign corporation that owns a U.S. LLC or domestic corporation—is frequently implemented for estate tax protection. Because the non-resident individual owns shares in a foreign entity rather than U.S. real property directly, the assets are shielded from U.S. estate tax liabilities upon the foreign owner's death.

Investor Compliance and Administrative Procedures

Maintaining statutory compliance in the U.S. involves executing specific administrative steps.

First, foreign investors must obtain proper U.S. tax identification credentials: an Individual Taxpayer Identification Number (ITIN) for individuals or an Employer Identification Number (EIN) for corporate entities.

Second, investors establish ongoing compliance by filing annual returns—Form 1040-NR for individuals or Form 1120 for corporations—to report gross revenues, claim allowable deductions, and record accumulated depreciation.

Third, prior to executing a property sale, an investor may submit Form 8288-B to the IRS to request a Withholding Certificate. An approved certificate permits the buyer to withhold an amount based on the estimated actual capital gain tax rather than the standard 15% gross transaction price.