Do foreign nationals pay real estate tax?

Key takeaways:

• Foreign nationals are taxed differently based on residency status, with nonresident aliens generally taxed only on U.S.-sourced income while resident aliens are taxed on worldwide income.

• Rental income from U.S. real estate is typically taxed at a flat 30%, but investors can elect to treat it as business income to deduct expenses and reduce taxable income.

• Unlike most other assets, U.S. real estate capital gains are taxable for foreign nationals and are subject to mandatory FIRPTA withholding of 15% of the sale price.

• Estate and gift taxes can be significantly higher for non-domiciled foreign nationals, who receive only a $60,000 exemption compared to multi-million dollar exemptions for U.S.-domiciled individuals.

U.S.-based real estate can be an especially attractive investment for high-net-worth foreign nationals seeking to protect family wealth. The U.S. real estate market offers a wide range of residential and commercial investment opportunities, with robust protections for property owners — whether or not they are American citizens. However, the U.S. tax system can be quite complex and challenging to negotiate for foreign nationals involved in real estate transactions. Professional advice based on your specific situation is always recommended; this article can provide a general overview of key tax implications to consider, including:

• Your tax status as a foreign national

• The type of real estate earnings

• The tax jurisdiction — federal, state, or local

• Whether there is a tax treaty with your country of residence

Who is a foreign national for tax purposes?

Generally speaking, a foreign national is any individual who is not a citizen or resident of the United States. Residency and identification as a foreign national are crucial for tax purposes, as they determine the applicability of FIRPTA (see below) and other tax obligations, based on the "substantial presence" measure:

• Resident aliens are typically subject to tax on their worldwide income, much like U.S. citizens — including expat Americans who live abroad and never set foot in the U.S.

• Generally, nonresident aliens are only taxed on U.S.-sourced income — excluding their U.S-sourced non-real estate capital gains, for which they are not taxed. However, if a non-resident alien is present in the U.S. for 183 days or more during the taxable year, there is a 30% tax imposed on their net U.S-sourced capital gains.

If you are planning to transfer a U.S. real estate asset to a family member, real estate tax consequences can be further complicated by IRS "domiciliary rules" and the estate tax disparity: Individuals in the U.S. on nonresident visas (such as G-4 visas) may be considered U.S.-domiciled for estate and gift tax purposes, even though they are considered nonresidents for U.S. income tax purposes. This matters when the time comes to transfer U.S. assets to other family members, because there's a significant estate tax disparity¹:

• Generally speaking, a U.S. citizen or foreign national domiciled in the United States gets a $15,000,000 estate tax exemption (2026); after that amount, their estate is responsible for up to a 40% tax.

• Non-domiciled foreign nationals get just a $60,000 exemption — and are responsible for up to 40% of estate taxes above that amount.

If you plan to leave the property to a family member at death, your estate may be subject to U.S. federal estate tax on the value of the U.S. real estate above the applicable exemption. However, U.S. capital gains tax is generally not triggered at death due to a step-up in basis, and FIRPTA withholding does not apply to transfers occurring at death.

How are different types of real estate earnings taxed?

For the purposes of this article, we’ll focus on the two main types of real estate earnings: Rental income, and capital gains from the sale of a property.

Taxes on rental income

U.S. citizens are required to report and pay U.S. tax on their worldwide income, including income from foreign real estate, regardless of where they live. Similarly, foreign nationals must report rental income from U.S. properties on their U.S. tax returns.

The IRS defines income from rent as Fixed, Determinable, Annual, or Periodical (FDAP) Income. These passive earnings are ordinarily taxed at a flat 30%. However, foreign nationals can choose to have this income treated as "Effectively Connected Income" (i.e., business-connected income), making a Section 871(d) election. This allows the owner to deduct expenses such as maintenance, mortgage interest income, and local property taxes, so that taxes are only owed on the net income from the property.

What about taxes on foreign properties?

Foreign property owners who file U.S taxes must also report rental income from properties located in a foreign country on their U.S. return, although they may be able to deduct foreign property taxes and mortgage interest if the property qualifies as a primary or secondary residence, which can reduce their taxable income. Additionally, foreign property owners can use the foreign tax credit to offset U.S. taxes with foreign taxes paid on rental income. The foreign tax credit allows U.S. taxpayers to reduce their U.S. tax liability by the amount of foreign taxes paid on rental income, helping to avoid double taxation and further lowering taxable income.

Taxes on real estate capital gains

While nonresident foreign nationals are generally not subject to U.S. tax on capital gains from assets such as stocks or businesses, an important exception applies to U.S. real estate. In addition, nonresident aliens who are physically present in the United States for 183 days or more during a taxable year may be subject to a 30% tax on their net U.S.-source capital gains.

Mandatory FIRPTA withholdings on real estate transactions for foreign nationals

The Foreign Investment in Real Property Tax Act — FIRPTA — was enacted in 1980 to help ensure that foreign nationals — who may not have other U.S. assets or economic ties — pay capital gains taxes on their profits from any U.S. real estate transactions. Under FIRPTA, a real property interest includes not only parcels of land but also stock in U.S. corporations that primarily hold U.S. real estate assets. Although there are some exceptions, the act requires a mandatory 15% withholding of the entire sale price on U.S. property sold or transferred by a foreign national to another owner — even if the property was sold for no gain or at a loss.² Importantly, this 15% withholding tax still applies if the property is transferred to a family member as a gift or as part of the owner's estate in the event of their death. FIRPTA also applies to sales involving a real property holding corporation, not just direct ownership of real estate.

What about real estate taxes at the state and local level?

The issues and rules discussed above relate to taxes levied at the federal (or national) level. However, taxes in the United States can be imposed at the state and local levels as well. At least 35 U.S states impose a tax on the transfer of an interest in real estate: each property is an immovable asset situated in a specific state or territory (such as Puerto Rico, Guam, or the District of Columbia).³

A foreign national investing in U.S. real estate needs to take these local taxes into account as well. Property tax rates are generally set by each state as a percentage of a property’s assessed value, but there are wide variations from state to state, ranging from 0.27% in Hawaii to 2.23% in New Jersey, and there can also be local rate variations among different locales in the same state.⁴ While property taxes are generally the same for foreign nationals and U.S. citizens, many states with high levels of second home ownership (for example, Vermont) offer tax discounts for state residents, which effectively raises rates for non-state residents — whether they reside in New York or New Guinea.

Finally, most states impose some form of taxes on real estate transactions, ranging from capital gains taxes to things like “recording fees,” “transfer taxes,” and even “stamp taxes,” which are essentially different names for sales taxes. Specific terminology and rates for these levies vary from state to state.

A tax treaty could lower your tax liability

The United States has tax treaties with dozens of foreign countries, which can help simplify compliance and reporting rules and importantly, help foreign nationals reduce the chances of being taxed twice on the same income. Tax treaties can also set a maximum tax rate that the foreign country can charge on certain types of income, potentially lowering the overall tax burden for U.S.-domiciled taxpayers.

However, it’s important to note that each treaty is unique, with rules and benefits that can vary significantly. Some may cover capital gains on real estate transactions, but others may focus on earned income or estate taxes. To better understand the tax treaty implications for your situation, you should seek appropriate legal and accounting advice for the specific jurisdictions in which you reside and have assets.

Lessening the impact of estate taxes on real estate capital gains

If you own property in the U.S. that you want to transfer to a family member but are concerned about estate taxes on family wealth, consider looking into using U.S. life insurance ownership as a way to help overcome the estate tax disparity.

Nonresident life insurance can help mitigate tax consequences and facilitate the transfer of assets to heirs because death benefit payments are generally exempt from federal estate taxes. That also means that money is transferred to beneficiaries without going through the probate process, which can be time-consuming for a large estate. These features could make life insurance an attractive wealth-transfer vehicle for many foreign nationals with U.S.-based assets.

U.S.-denominated life insurance can help provide the liquidity needed to cover potential capital gains or estate taxes and smooth the process of transferring real estate or other assets to your heirs without forcing a sale.

Permanent cash value life insurance can provide a number of other advantages when it comes to tax and estate planning and family wealth preservation:

• Portfolio diversification and risk mitigation: Permanent, whole life insurance builds cash value at a guaranteed rate and is among the more conservative financial products available.⁵ An individual or survivorship life insurance (couple’s) policy can build US-denominated cash value that can be accessed while the policyholder is still alive, acting as a potentially effective hedge against economic downturns in one's home country, fluctuating exchange rates, and other forms of geopolitical risk.⁶

• Asset protection: Life insurance policies are generally protected from creditors and bankruptcy.⁷ This can provide an additional layer of protection for foreign nationals' assets.