Tax Challenges: Foreign Owned U.S. Real Estate Via Single-Member LLC

Forbes

2 days ago

Foreign investors using single-member LLCs to hold U.S. real estate face complex U.S. income and ... More estate tax implications, including 30% withholding on rental income, FIRPTA withholding upon disposition and potential 40% estate tax. Various strategies can reduce the tax bite.
For some time, foreigners have been drawn to the U.S. real estate market due to its stability, potential for appreciation, and the reliable legal framework in America. A frequently used investment vehicle is a single-member limited liability company created under the laws of a U.S. state.
A SMLLC offers liability protection and flexibility. The U.S. tax implications for nonresident aliens or foreign entities owning U.S. real estate through an SMLLC are complicated, yet too often, investors do not consider the tax issues. These involve different U.S. tax regimes: income tax, estate tax, and compliance with rules under the Foreign Investment in Real Property Tax Act.
This article explores these tax consequences and key considerations for structuring such investments when the U.S. SMLLC is owned by an NRA individual.
A SMLLC is a business entity with one owner. Typically the SMLLC is treated as a "disregarded entity" for tax purposes unless the NRA owner makes an election for the SMLLC to be taxed as a corporation. Absent such an election, the LLC's income and expenses will flow through to the individual and the individual will be taxed as if he holds the real estate directly.
Certain non-tax benefits exist with the SMLLC structure. It provides liability protection, shielding the individual's personal assets from liability claims associated with the real property owned by the LLC. It can also simplify obtaining insurance when compared to direct ownership by a foreign individual. Many investors do not realize, however, that privacy can be compromised since many states require public disclosure of the LLC owner. States vary in their LLC disclosure requirements; investors concerned with confidentiality should investigate the rules prior to formation.
Unless the rental activity is regular and substantial such that the LLC is considered as engaged in a U.S. trade or business, rental income from U.S. real estate owned by an NRA through an SMLLC is generally classified as so-called Fixed, Determinable, Annual, or Periodical income. FDAP income is subject to a flat 30% withholding tax on the gross rental amount, with no deductions allowed for expenses such as depreciation, maintenance, advertising, or interest. Absent a lower tax rate that may apply under a relevant treaty, a 30% withholding tax can significantly reduce net rental returns.
To avert this problem the NRA can make a special election to instead be taxed on net rental income at graduated U.S. tax rates (up to 37% for individuals), thus enabling deductions for expenses such as depreciation, property taxes, and mortgage interest. The election is made by attaching a statement to the individual's U.S. income tax return or amended return. The NRA must also provide Form W-8ECI to the withholding agent/payor of the rental income. Once the election is properly made, it applies to all U.S. real property held for income production and remains in effect unless revoked. The rules for revoking the election can get tricky, as revocation may require IRS consent in certain cases.
The sale of U.S. real estate held through an SMLLC is subject to tax under the Foreign Investment in Real Property Tax Act. For a NRA investor, FIRPTA will tax the gain (sale price minus adjusted basis) at capital gains rates. If the property was held for more than one year, the long-term capital gains rate will not exceed 20%.
FIRPTA requires the buyer to withhold 15% of the gross sale price (not the gain) as a prepayment of the FIRPTA tax. FIRPTA was enacted to prevent tax evasion by ensuring that the IRS could collect the tax from the buyer. Collection from nonresident foreign investors would become very difficult once the sales proceeds were transferred offshore.
If the withholding exceeds the actual tax liability (for example, when the real property is sold at a loss), the NRA can file for a refund. With advance planning, a special FIRPTA withholding certificate can be obtained from the IRS to reduce or eliminate withholding when the expected tax liability would be less than the 15% withheld amount.
For example, if an NRA purchases a property for $1,000,000 and sells it for $1,200,000, the taxable gain is $200,000, potentially taxed at 15–20%. However, the buyer must withhold $180,000 (15% of $1,200,000), which may exceed the actual tax liability. Applying for an IRS withholding certificate could resolve the overwithholding in advance. Alternatively, the NRA can file Form 1040-NR to obtain a refund for tax that was overwithheld.
An NRA holding U.S. real estate through an SMLLC must file Form 1040-NR annually if they receive rental income or when the property is sold. Additionally, foreign-owned SMLLCs must file Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business) to report transactions between the LLC and its foreign owner, even if no tax is owed. An Employer Identification Number is required for the SMLLC, and a responsible party must be designated.
The SMLLC is formed under the laws of a U.S. state and as a U.S. entity, it could have FBAR filing obligations. Even though the SMLLC is disregarded for U.S. income tax purposes, it is not disregarded for purposes of the Bank Secrecy Act. This means that if the SMLLC has any foreign financial accounts, an FBAR must be filed each year reporting these if the dollar threshold is met for all aggregated foreign accounts.
U.S. estate tax applies to NRAs on assets situated in the U.S., including U.S. real estate. What happens when U.S. real estate is held through a SMLLC? The IRS view is that since an SMLLC is disregarded for tax purposes, the underlying real estate is considered directly owned by the NRA, making it subject to estate tax upon the death. The estate tax rate can reach 40%, with a lifetime exemption of a paltry $60,000 for NRAs. This comes as a surprise when compared to the 2025 $13.99 million for U.S. citizens and domiciliaries. This creates significant estate tax exposure, especially for high-value properties. If the IRS view prevails, the SMLLC provides no inherent estate tax protection since the real estate is treated as directly owned by the NRA at death. If instead, the SMLLC interest were to be valued in the estate, there is the potential for valuation discounts.
The U.S. has negotiated estate tax treaties with 14 countries including France, Germany, and the UK. A treaty may reduce or eliminate estate tax liability by redefining situs rules or providing credits for foreign estate taxes that are paid. Foreign investors should work with tax professionals to understand if treaty benefits might be available to leverage certain benefits.
Estate tax exposure can be mitigated with use of alternative structures, such as holding the U.S. real estate through a foreign corporation or a multi-tier structure (e.g., a foreign corporation owning a U.S. LLC taxed as a corporation). Shares in a foreign corporation are generally not considered U.S. situs assets, and upon death they are not included in the NRA's taxable estate. These structures, however, will result in compliance complexities. They may also introduce corporate-level taxes (21% federal plus state) and potential branch profits tax (up to 30%, unless reduced by a treaty) on repatriated earnings.
The NRA can consider purchasing life insurance to cover potential estate tax liability as a cost-effective way to mitigate risk without restructuring ownership. Proceeds from life insurance policies on the NRA's life are generally exempt from U.S. estate tax.
Investors to the U.S. are warned that if they are taxpayers from certain countries that are treated as 'discriminatory foreign countries,' a proposed change to the tax laws in the One Big Beautiful Bill would increase the U.S. tax and withholding rates on their U.S. income, impacting for example, FIRPTA gains, FDAP, business income, branch profits). These foreign persons could be subject to significantly higher U.S. tax rates commencing at 5% and escalating annually (up to 20%) if their country of tax residence or incorporation is treated as a jurisdiction imposing unfair taxes (such as digital services tax) on Americans.
Holding U.S. real estate through a single-member LLC offers foreign investors liability protection and operational simplicity. Ownership through a SMLLC, however, does not inherently reduce U.S. income or estate tax burdens.
Certain steps can be taken to address U.S. tax concerns:
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