Real Estate

Structuring Business and Real Estate Opportunities in the U.S.

By Gary J. Freedman and Vanja Habekovic, Ervin Cohen & Jessup LLP

As the world’s economies continue to struggle making investments and seeking business opportunities internationally, a critical analysis of how to structure, finance, operate, grow and eventually liquidate the opportunity is imperative. Ambitious plans are often derailed or delayed and certainly made more costly, because at the outset the crucial aspects and phases in the life cycle of investments, whether real estate or business, have not been carefully considered.

Imbedded in the desire to increase profits and value is the vision of the investor or business enterprise, which will differ depending on industry or personal ambition and can range from wealth diversification, to increasing product market share, reducing production time and/or costs. There may be tax efficient ways of structuring these opportunities that vary from case to case and jurisdiction to jurisdiction. It is the purpose of this article to summarize the issues that should be considered and to give some preliminary guidance, while bearing in mind that each investment must be considered in light of its unique and individual characteristics.

Investment Timeline

There is always an anticipated life span for each investment. So, the first step in structural planning is the time horizon, as it will determine most of the decisions that will follow, as a consequence.

The exigencies of successful real estate and business investing require this discipline. The capital required and the debt to equity ratio are of primary concern, unless the real estate, for example, is purchased for all cash. If debt financing is required, the attendant risks include: the amount of debt, its placement, duration, interest rate, repayment, ability to refinance and anticipated cash flow. These factors must be considered at the outset in order to mitigate the risk of sustaining the investment. In order to achieve the highest rate of return, the leverage needed to complete the purchase and/or the successful operation of the asset and its growth will affect the success of the investment. Therefore, consideration must be given to a structure that is lender-friendly.

Investment Structure

A myriad of investment structures are available to foreign investors in the U.S., and the particular objectives and concerns of each investor and investment will drive the appropriate structure. The most common objectives include privacy, limited liability, minimizing income and estate tax liability, and reducing U.S. tax filing obligations. The choice of structure is also impacted by the type of financing required. Whichever structure is appropriate, the investor should take care to follow the appropriate corporate formalities and filing requirements in the jurisdiction where the entity is organized.

Some frequently used investment structures for a U.S. business or real estate include:

Direct Investment – While the simplest approach, the structure offers no privacy or liability protection. It requires filing personal U.S. income tax returns by the investor. The investor would pay tax on operating income at a maximum 39.6% rate federally. Gain on the sale of real estate or other assets held for over a year are eligible for the 20% long-term capital gain rate. A sale of real estate would be subject to a 10% withholding tax on the sales proceeds. Any U.S. asset, whether a business or real estate, is subject to U.S. estate tax at a maximum rate of 40% if owned at death. Nonetheless, direct investment is a relatively tax efficient structure as there is only a single layer of tax and gain on the sale of assets taxed at favorable capital gain rates.

U.S. Corporation – Unlike direct investment, a domestic corporation provides privacy and limited liability. The corporation (not the individual investor) must file and pay U.S. income taxes at a maximum 35% rate. In addition, dividend distributions to the foreign shareholder are subject to a 30% withholding tax, which may be reduced under an applicable treaty. In other words, this structure results in double taxation – once at the corporate level and then again at the shareholder level when there is a distribution. Sales of capital assets, including real estate, are not eligible for capital gain rates. If the U.S. corporation owns real estate, then a sale of the stock would result in a 10% withholding tax and the filing of a U.S. income tax return by the individual investor. Stock in the U.S. corporation held by the investor at the time of death would also be subject to the estate tax. Notwithstanding these tax inefficiencies, a U.S. corporation is commonly used for venture capital financings. With proper planning some of these tax issues can be resolved or minimized. For example, if the shareholder of the U.S. corporation is a foreign corporation, the estate tax is avoided.

Foreign Corporation – Just like a U.S. corporation, a foreign corporation will provide an investor with limited liability and privacy. The foreign corporation will be subject to the “branch profits” tax which will replicate the double tax of a U.S. corporation described above. However, the branch profits tax is imposed regardless of whether there is a distribution, and thus the timing and amount of the tax cannot be controlled as is possible with dividend distributions from a U.S. corporation. The foreign corporation, just like a U.S. corporation, is not eligible for capital gain tax rates. The main advantage of this structure is that the stock of a foreign corporation is not subject to the U.S. estate tax.

U.S. Limited Liability Company (“LLC”) – This structure affords a foreign investor confidentiality and creditor protection. An LLC with multiple members can elect to be taxed as a corporation or a partnership for tax purposes. If partnership tax treatment is elected, the profits and losses of the company would flow directly to the investors resulting in one level of tax as opposed to the double taxation of a U.S. corporation or foreign corporation structure. However, this structure may require the LLC to withhold tax on the foreign partners share of income, whether or not distributed, which may cause a liquidity problem for the company. The U.S. investor must pay U.S. income tax on operating income and gain on the sale of assets just like direct investment. The investor would also be required to file U.S. tax returns. The investor remains subject to estate tax on their interest in the LLC.

Whatever structure is chosen, it is paramount that the tax structure does not encumber the operational aspects of the investment. So, time must be spent with management and the accounting staff so that they understand and become comfortable with reporting requirements both internally and to regulatory agencies in a timely manner. Additionally, state and local taxes, including real property taxes and sales taxes need to be considered. Of course, applicable tax treaties should be analyzed as well, as they may reduce the tax burden of a particular investment.

Finally, care must be taken to ensure the foreign investor does not become a U.S. resident for tax purposes which would subject the investor to U.S. taxation on world-wide income. Simple ownership of U.S. real estate or a U.S. business would not make a foreign person a U.S. resident for tax purposes. However, spending a significant amount of time in the U.S. could render a foreign person a U.S. tax resident.

Conclusion

All the factors discussed above must be considered before determining the optimal structure for your investment in a U.S. business or real property. In our experience, there is no one size fits all solution, but with appropriate advice and counsel a structure can be achieved that meets all of an investor’s needs.


Gary J. Freedman, Partner
Ervin Cohen & Jessup LLP, 9401 Wilshire Boulevard , 9th Floor Beverly Hills, CA 90212-2974, USA
T:  (310) 281-6313; F: (310) 859-2325
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Vanja Habekovic, Of Counsel
Ervin Cohen & Jessup LLP, 9401 Wilshire Boulevard , 9th Floor Beverly Hills, CA 90212-2974, USA
T:  (310) 281-6377; F: (310) 887-6816
M: This email address is being protected from spambots. You need JavaScript enabled to view it.; W: www.ecjlaw.com


published: May 2014

 

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