How is rent calculated as income tax in USA?
Aug 17, 2010 at 8:47 PM Thread Starter Post #1 of 12

Konig

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I have a question on tax issues for foreigners owning real estate in USA. It seems that rents are taxed at 30% withholding tax flat unless I file US income tax return. When I looked at different income tax brackets like 10% for $0-8475, does the amount mean purely my collected rent or collected rent - expenses like agent fees, repair, insurance etc? Lets say my rent per year is $20000 and expenses incurred per year is $5000, do they consider my income as $20000 or $15000?
 
The next question is the long term capital gains tax. It seems that the capital gains tax bracket is tied down to your income tax bracket? Does that mean if your rent income remains in the 15% tax bracket then your capital gains tax will only be 10% as long as you hold the property for 5 years?
 
Parents wanted to buy an investment property in USA but the tax system is a real bitch to navigate!
 
Thank You in Advance
 
Aug 17, 2010 at 9:34 PM Post #3 of 12

El_Doug

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Youre going to need an international tax specialist, most likely one who is a lawyer, to answer these questions - make sure to get one in the state(s) in which you own property
 
Aug 17, 2010 at 9:35 PM Post #4 of 12

Konig

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hiring a tax specialist for 2 general questions sounds overkill. I'd prefer to hire them for hard number analysis which may be beyond my realm of interest.
 
Aug 17, 2010 at 9:36 PM Post #5 of 12

El_Doug

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these are not general questions, though.  there are hours of research to be done, which will require the expertise of someone familiar with both international and real estate taxation. 
 
Aug 17, 2010 at 11:58 PM Post #7 of 12

Uncle Erik

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Quote:
I have a question on tax issues for foreigners owning real estate in USA. It seems that rents are taxed at 30% withholding tax flat unless I file US income tax return. When I looked at different income tax brackets like 10% for $0-8475, does the amount mean purely my collected rent or collected rent - expenses like agent fees, repair, insurance etc? Lets say my rent per year is $20000 and expenses incurred per year is $5000, do they consider my income as $20000 or $15000?
 
The next question is the long term capital gains tax. It seems that the capital gains tax bracket is tied down to your income tax bracket? Does that mean if your rent income remains in the 15% tax bracket then your capital gains tax will only be 10% as long as you hold the property for 5 years?
 
Parents wanted to buy an investment property in USA but the tax system is a real bitch to navigate!
 
Thank You in Advance


Maybe I can help a little.
 
First, what kind of entity is holding the rental units?  The taxes will be different depending if you have a corporation (and what kind of corporation) or whether you're holding them as an individual.
 
Second, I haven't done anything with the taxation of foreign propertyholders, so I don't know if you'll be taxed differently.  Am pretty sure you have to file a US return, though.
 
Also, withholding is different from taxes actually paid.  The IRS likes to get payment in advance (often quarterly for businesses) and the 30% withholding may or may not be all that you have to pay.  You might have to give them 30% every quarter, but with enough deductions and credits, you might get a refund.  On the other hand, the 30% might not be enough, so you'll have to pay more.  It all depends.
 
You'll have to declare all of your income.  If you take in, say, $20,000, you have to declare all $20,000 as income.  You will be able to deduct fees for management, repairs, depreciation, and a number of other things.  So if you have, for example, $5,000 of allowable deductions, you'll be able to subtract $5,000 from the income reported.  Those come "above the line," so they deduct from the amount you're taxed on.  So if you have $20,000 in income and deduct $5,000, you'll pay taxes on $15,000.
 
Other deductions and some tax credits go "below the line," which means that they deduct from the amount of tax you have to pay.  And there are a number of tax credits out there.  You can earn them from using efficient technologies and quite a few others.  So, if you get, for example, an $800 credit for buying a "green" air conditioning unit and you owe, say, $3,000 in taxes, the credit will lower the amount owed to $2,200.
 
Capital gains are a little trickier.  Short-term capital gains are taxed according to your income tax bracket and long-term gains are taxed at 20% if you are in the 28% or higher tax bracket, and only 10% if you are in the 15% bracket.  Short term capital gains are investments under one year and long term capital gains are investments over one year.  The goal of the tax system is to encourage long term investments.  Also, you'll only be taxed on the difference between what you pay and what you sell for.  For example, if you bought at $100,000 and sold for $150,000, you'd be taxed on $50,000, not $150,000, because $50,000 is your gain on capital.
 
Also, be very, very, very careful where you invest in the United States right now.  The real estate market is incredibly dangerous.  If you look at the long-term Case Schiller Index, you'll notice that values are still inflated over the norm going back about 110 years.  Some properties might seem like a good idea right now because they're 50% or more off the peak values from 2007, but even at 50% off, they might still be grossly overvalued.  There have been lots of odd happenings between the banks and the government, so the market has not returned to normal.  Some parts of the country are still inflated.
 
Another worry is property taxes.  They're limited in some states, but others are just itching to soak people to make up budget shortfalls.  Property taxes aside, some cities and counties just nail you for permits and things you might not consider.  Down in the desert, one city charges between $20,000 and $25,000 for a new water meter.  That's not a typo and it's killed construction and remodels.  A local restaurant my family loved (it sadly closed recently) was hit for a $10,000 sewer assessment by the city.  One of many reasons for closing, but the owner wasn't happy about it.  Sometimes cities force you to pay for undergrounding utilities, new sewer/water projects, and much else.  Be careful.
 
Finally, see if the property falls under some kind of HOA.  Those are pure evil - I don't have anything to do with them.  HOAs are given broad powers and they're weird about some things.  For instance, you might get fined if a tenant parks in the driveway instead of the garage.  You can get fined if non-permitted holiday lights are put up.  And lots and lots of other little things.  The awful part is that if the fines go unpaid, the HOA sometimes has the right to foreclose on the property to recover even a couple hundred dollars of unpaid fines.  You better believe there's a lot of litigation around that.  The HOA might also take a vote and decide to repaint all the properties, get new roofs, install a clubhouse, or any number of other projects.  So, on a whim, you might get put on the hook for a $15,000 assessment to pay for a new clubhouse and swimming pool.
 
Anyhow, there are a lot of pitfalls to property ownership here.  This just kind of skims the surface - you have to stay on top of things.  That being said, there are a lot of benefits to owning and renting property.  That's my family business and it's pretty good.  We do the maintenance and management ourselves, so that saves quite a bit of money.  Also why I went to law school and picked up a degree in accounting - it pays off if you know how to play the game.
 
Aug 18, 2010 at 4:52 AM Post #8 of 12

chesebert

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OP: any clue what CCH is for? if not, get an international tax lawyer or one of the several international accounting firms.
 
Laws you probably should consider: the US Fed tax code, the state (where your properties reside) tax code, any treaties US has with your country, any executive agreements US has with your country regarding taxation, if there is any, and your country's tax code.  (if you are using an off-shore vehicle, also look at the tax code of the jurisdiction of the off-shore corp).  - - -  boy, that's a lot of research :D
 
You also need to be advised of the state law governing lessor/lessee.
 
I am going through the same crap right now (forced to be a lessor by the market) - selling house in MI is next to impossible with all the foreclosures and short sales.
 
Honestly I question the wisdom of owning any real property in the US right now.  Why can't you just get yourself some nice investment grade corp bonds and call it a day? I think you should have a serious talk with your financial adviser.
 
Aug 24, 2010 at 10:07 PM Post #9 of 12

Konig

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WOAH!! sometimes the diversity of head-fi's talents and knowledge amazed me to no end!
 
Thanks uncle erik for the sound advice. Have been tracking the case shiller index for a long time and real estate is still a falling knife to catch. However, one has to bet against the market at some point to make money. I realized in the wealthier established towns there are always people with tonnes of cash saved in their bank ready to pounce when real estate stabilize, by then its too late to buy the house you want. They don't sell because they don't need to like in many parts of Asia  when those people can afford to make mistakes and they have a strong reserve to fight off lowballs. Case shiller indicated current home prices at autumn 2003 but Im looking at a house who accepted an offer of 1999 june price (2nd owner bought the house slightly above my offer in 1999, current owner bought it at 35% above my offer in july 2004 so Im offering a 1999  price). Owner keen to sell because property on the market for a year and quick closing is a main attraction for him because we pay cash. Under the median scenario of sub par economic growth, I expect home prices to bottom in 2012/2013 and keep a L trajectory for awhile as long as economy keeps itself out of deflation spiral. However, you may never get the house you want in those years and house hunting in usa is quite a bitch because EVERY HOUSE IS DIFFERENT. Wanna get it done and over with. 
 
Even if the economy gets into a deflation spiral, we'll just take it as having a bad investment vacation home so we are there long term for as long as parents are alive. We can wait 30 years without a problem. I think owning a property in usa is all about knowing how to fight off the tax robbers at all levels in a legal way once you set up a contingency fund for the property. I was first amazed at how desperate all sorts of people try to take money out of home owner's pockets and the govt is wondering why people are holding off buying homes I mean lol??
 
The places that had fallen off 50% from peak are likely to become ghost towns anytime soon. I believe towns around metros that provide millions of jobs will always have a natural price floor. Nobody can predict the bottom but as long as you've accepted the risk and has enough funds to cater for the risks, it isn't a bad time to own a long term property. Property speculators should keep aside for now and wait for clarity.
 
Aug 24, 2010 at 11:21 PM Post #10 of 12

Uncle Erik

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I don't know if 1999 levels are even such a good deal - it would depend a lot on where the property is.  If you can buy and hold, it's a place you really enjoy and might live at, then it might be OK.
 
Also think about how weird mortgages have gotten lately.  When we bought the place in Arizona a few months back, we were able to demonstrate annual income over four times the value of the property.  Not only that but we have equity in paid-off properties much more than the value of the house and even more cash than the asking price.  But one bank didn't want to make the loan and another hemmed and hawed, requiring more and more information, more paperwork, and seemed hesitant.  Long story short, we dumped most of the stock and pulled a little cash to buy the place outright.  Not trying to brag, but even with tons of income and assets, we still had to pay cash.  It was worth it, since family will stay there almost every week and I'll be knocking around the workshop in the evenings.
 
We also tried to buy the place in July 2008.  We offered the asking price, had 20% down, were qualified for a 15 year fixed, everything.  And we got turned down twice.  Then the place sat empty and unlisted for almost two years, before they listed it for 20% less and made a bunch of nice improvements, including painting the outside and putting up a very nice concrete brick wall.  My only guess is that the bank held off on the sale to get bailout funds, then dumped the place cheap.  There seems to be some kind of unholy alliance between the fed and big banks - the banks are receiving lots of free money for bad assets, that they then use to buy bonds from the fed propping up their printing of more money.  It looks like a Ponzi scheme to me.
 
So be careful out there; it's very weird.  I agree that things are going to bottom out around 2012-2013, because that's when the Option-ARMs and Alt-A mortgages are going to melt down.  They'll bring down prime when that happens.  Keep in mind that the subprime meltdown was only about 25%-30% of the market, so the worst is yet to come.
 
There's also a huge "shadow inventory" of property.  There's a lot of stuff that's been foreclosed on but isn't put on the market.  They're trying to choke off supply to keep prices high.  They're also doing the same thing by not foreclosing on every delinquent mortgage.  Some people have not been paying for over two years and still haven't been foreclosed on.  So the supply of property is a lot higher than it appears.  They just don't want prices to collapse.  But banks can't sit on overpriced houses forever, since they have to pay for property taxes on the inflated prices.
 
The other scary thing is that a lot of corporate bonds are going to roll over at the same time, and I think a lot of those will be defaulted on.  It doesn't look good.
 
If you need to invest some money, it might make more sense to put it into safe assets and wait for things to bottom out.
 
Aug 25, 2010 at 12:18 AM Post #11 of 12

Konig

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The option ARM meltdown and Alt A mortage meltdown does simplify things but Im not sure if it will happen. It all depends if the FED can fool the corporate world to spend their cash and start hiring by 2012. To me, Jobless rate seems to have bottomed and will slowly go up in a zig zag pattern. As long as the world economy can simply wriggle through to marginal positive growth, corporate with tonnes of cash start hiring, we should see a bottom forming in 2012.
 
The problem now is what happens if USA suffer from a long term structural unemployment beyond 2012. Maybe USA is too big to be saved as opposed to too big to fail but in my experience, USA can always provide certain value to outsiders. Just look at the tonnes of immigrants who bought conditional green cards by investing $ 1/2 mil in poor quality chicken farms or useless convention centers in distressed states. After looking at the big picture, I see 2010 is the year to make a bet that a good bottom will form in 2012. I also made sure we avoided those 5000 sq feet+ still million dollar mansions which sound totally irrelevant in the new economic normal (can't afford anyway). If things do get worse we have left enough $ to buy another one to avg down so buying now is also part of risk hedging.
 
 
 
Aug 25, 2010 at 9:17 AM Post #12 of 12

Konig

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uncle erik, YGPM
 

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