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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
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.
