Understanding taxes is essential for current and prospective property owners, especially foreign investors interested in the U.S. real estate market. Owning U.S. real estate, whether in your personal name or through an entity, can lead to U.S. federal and state income taxes, which can have significant tax implications. The penalties for failure to comply with your tax obligations can sometimes put you in a difficult position, leading to hefty fines and legal complications. We want to share an overview of the tax considerations for owning rental property, whether deductible expenses, depreciation, or different tax strategies, to help you manage property ownership taxes.
INCOME TAXES
Income Taxes on Rental Properties
Property owners must comply with taxes on rental income and eventual capital gain taxes that result from property sales. Additionally, the county assesses real estate taxes annually, which are separate from income taxes based on property income. These taxes apply uniformly to U.S. citizens and foreigners, although owners who maintain a principal residence in Florida can benefit from the homestead exemption. Generally, foreign investors do not qualify for this benefit.
For U.S. persons, rental income is reported on their U.S. income tax return, IRS Form 1040. Non-U.S. persons face a default 30% tax on gross rental income. However, they can elect to file a U.S. income tax return and be taxed on net income after deductions. This election applies to all subsequent tax years unless revoked within three years or with IRS consent.
Deductible Expenses
When filing an income tax return, various expenses such as mortgage interest, property insurance, association dues, real estate taxes, and utilities (if not paid by the tenant) can be deducted.
Depreciation
Depreciation is mandatory, and it lets property owners spread out the cost of real estate over several years, providing annual tax deductions. Residential rental property is depreciated over 27.5 years, while commercial property is depreciated over 39 years.
Additionally, assets expected to last more than a year must be depreciated rather than expensed, but they might be eligible for bonus depreciation or other accelerated tax deductions. Cost segregation might also be of assistance, allowing part of the purchase price to qualify for bonus depreciation based on the property’s cost and the owner’s objectives.
Florida Sales Tax on Rentals
In Florida, a 6% sales tax applies to short-term or transient rentals (six months or less). Residential rentals longer than six months and one day are exempt, while commercial rentals must collect and remit sales tax regardless of the lease term.
Taxes on Property Sales
The U.S. taxes the sale of real estate, with gains on properties held for less than a year taxed as ordinary income rates. Long-term gains benefit from lower capital gains tax rates, with a maximum of 20% for individuals. Depreciation recapture is taxed at up to 25% for individuals.
FIRPTA: Tax on Foreign Sellers
The Foreign Investment in Real Property Tax Act (FIRPTA) requires non-U.S. persons to withhold a portion of the sale price as a tax prepayment. The final tax obligation is determined when a U.S. tax return is filed.
U.S. ESTATE TAX
Foreign investors must consider U.S. estate taxes. According to the IRS, U.S. citizens and residents have a significant estate tax exemption $13,610,000 million for individuals in 2024, whereas non-resident aliens have only a $60,000 exemption. U.S. situs assets, including real estate, are subject to estate tax, with rates up to 40%.
Some common strategies to mitigate U.S. estate tax for foreign investors include purchasing life insurance to cover potential estate tax liabilities, holding property through a foreign corporation (blocker corporation), setting up irrevocable trusts, utilizing Qualified Domestic Trusts (QDOTs) estate tax treaties where applicable, among others. However, these strategies must be implemented with a clear understanding of U.S. real estate tax laws. If you want to learn more, schedule a 15-minute free call with us here.
