US Property Capital Gains Tax for Non-Residents
Navigating the capital gains tax implications for non-residents selling US property can be complicated. This guide provides a comprehensive understanding of US tax law for foreign investors. It covers topics such as who is subject to capital gains tax, the relevant tax rates, and possible strategies for reducing tax obligations.
What is Capital Gains Tax?
Capital gains tax (CGT) is a tax on the profit earned from selling certain assets. These assets often include investments such as stocks, real estate, cryptocurrency, and personal property. If you sell US-based assets and make a profit, you may be required to pay capital gains tax.
Filing capital gains tax returns can be challenging for many non-residents in the US. This article provides all the information you need to file your income tax return before the deadline correctly. For citizens and resident aliens, capital gains are a part of their worldwide income, which means they are subject to US taxation.
Non-resident aliens (NRA) are subject to a 30 percent tax rate on US-source net capital gains if they are in the US for at least 183 days in the taxable year in which the gain occurs. The tax should be withheld at the source of the payment. The provision only applies if the NRA is not taxed as a resident under substantial presence.
Capital gains from US real property interests are taxable regardless of presence. Furthermore, capital gains by non-residents resulting from the sale of US partnerships with effectively connected income (ECI) are subject to US tax. Withholding requirements on the gross proceeds from selling US real property interests and partnerships with ECI also apply.
Who Is Considered a Non-Resident Alien?
The Internal Revenue Service (IRS) has two taxpayer classifications: resident and non-resident aliens. A resident alien typically meets the substantial presence test or is a green card holder. On the other hand, NRAs are individuals who do not have green cards and have limited physical presence in the US.
Non-US citizens are generally categorized as NRAs if they are not green card holders or if they do not pass the substantial presence tests. Examples of non-resident aliens include students, teachers, and those seeking medical treatment in the US.
You will be considered a Resident Alien if you meet the Substantial Presence test and will be taxed as if you were a US citizen. The Substantial Presence test first looks at the number of days you were physically in the United States for the year in question. If in any year you were in the US for less than 31 days, you did not pass the Substantial Presence test for that year. If you were in the US for 31 or more days, then the Substantial Presence test uses a formula to determine if you are treated like a Resident Alien or an NRA. If this formula calculates the total number of days over a three-year period to be 183 days or more, then the Substantial Presence test is met.
The formula works as follows. It first determines the number of days in a year that you were present in the US and uses all of those days towards the 183 required days. It then looks to the previous year and counts each day as 1/3rd of a day. For example, if you were present in the US for 30 days, then for this purpose, you would be considered present in the US for 10 days. It then looks at the next prior year, the third year, and counts each day as 1/6th of a day. For example, if you were in the US for 60 days, this would count as 10 days. Each day count is added from the first, second, and third years. If the calculated total is less than 183 days, the Substantial Presence test is not met. If the formula yields 183 days or more, then the Substantial Presence test is met for that first year, and the individual is therefore, taxed as a Resident Alien for that tax year.
General Rule for Non-Residents Selling US Property
When it comes to NRAs selling investments held in a brokerage account, they are usually not required to pay US capital gains tax.
However, it’s important to note that NRAs may still be responsible for paying capital gains tax in their home country. While the brokerage firm will not withhold any money, complying with your country’s tax regulations is crucial.
It’s worth mentioning that certain non-resident aliens may be subject to a 30 percent capital gains tax if they have been in the US for more than 183 days. That applies to non-resident alien students, scholars, and employees of foreign governments and international organizations. However, this rule only applies if their tax home has also shifted to the US.
Exception: Real Estate and FIRPTA
Under FIRPTA or the Foreign Investment in Real Property Tax Act, a specific rule requires buyers to withhold some of the sale proceeds from NRAs selling US real estate. This withholding amount is an advance payment toward any potential liability for capital gains tax.
The withholding rate depends on the sale price:
- Sales exceeding $1 million: 15 percent withholding
- Sales between $300,001 and $1 million: 15 or 10 percent depending on tax treaty benefits
- Sales of $300,000 or less: 15 percent or $0 depending on tax treaty benefits
Filing a US Tax Return To Recover Withheld Amounts
Suppose you are an NRA who believes that you are eligible for a reduced or zero capital gains tax rate due to a tax treaty or other factors. In that case, you can file a US tax return to recover some or all of the withheld amount. The procedure involves a form 1040NR.
Factors Affecting Capital Gains Tax Liability for NRAs
Most NRAs are exempt from paying capital gains tax on non-real estate US property. However, some circumstances can trigger tax liability. If an NRA meets the substantial presence test for a tax year, they may have to pay capital gains tax on the sale of any US property, including stocks and bonds. The substantial presence test is a formula that is applied to determine if an NRA has spent enough time in the US over the past three years to be considered a tax resident.
Additionally, suppose the US property is “effectively connected” with a US trade or business. Effectively Connected Income is any income that is earned directly from an actively run business based in the United States. In that case, any capital gains from its sale might be taxable. For instance, if an NRA owns a rental property in the US and actively manages it, the sale could be considered effectively connected.
How Much Capital Gains Tax Will I Pay as a Non-Resident?
The typical US capital gains tax rate is 30 percent for US-source net capital gains if you are in the US for 183 days or more of a tax year. If you live abroad during the whole tax year and invest in US stocks, you won’t pay CGT in the US, but you may need to pay it in your home country. Other US-sourced investment income, including dividends and interest earned from any source other than a US bank account, is taxable income that requires filing a 1040NR tax return. However, how much tax you must pay depends on several factors.
Tax Treaties
It’s important to note that the US has tax treaties with many countries, which can provide NRAs with reduced withholding rates or even complete exemptions from FIRPTA withholding. You should understand the tax treaty between your home country and the US to determine the potential benefits.
If you are not exempt from US tax, it’s crucial to be aware of the tax treaties that your country has with the US. These treaties may reduce or eliminate Capital Gains Tax (CGT), depending on your residency status at the time of sale and the nature of the asset.
Remember that you will face a 30 percent tax rate if you have spent 183 days or more in the US. That also applies if you did not provide the necessary tax forms (W-8Ben) to identify yourself as a foreign person eligible to use the tax treaty.
Income level
Note that your tax rate for Effectively Connected Income is influenced by your overall income, including income generated from your assets. Generally, individuals with higher incomes tend to face higher tax rates. So, it’s crucial to stay aware of how your income affects your tax obligations and plan accordingly to avoid unnecessary financial burdens.
State Laws and Regulations
When it comes to capital gains, laws can vary from state to state. Some states may have additional taxes that you must consider. Therefore, analyzing federal and state tax implications is crucial to avoid any inconvenience before making investment decisions. Doing so can ensure you’re making informed decisions aligning with your financial goals.
Duration of Stay
Capital gains income is generally not taxable for non-residents who spend less than 183 days in the US during a calendar year. However, if the non-resident spends 183 or more days in the United States, the capital gains income is taxable.
Strategies for Minimizing Capital Gains Tax Liability
Suppose you are a non-resident alien selling your property in the US. In that case, there are ways to minimize your capital gains tax burden. Here are some options:
- Claiming tax treaty benefits: If applicable, filing the appropriate forms to claim tax treaty benefits can significantly reduce or eliminate withholding requirements.
- Reducing capital gains: Be sure to include all amounts used to purchase and improve the asset. All major repairs, improvements, and renovations can be added to a property’s cost.
- Tax-deferred exchanges: Consider a Section 1031 like-kind exchange for real estate. That allows capital gains tax to be deferred by reinvesting the sale proceeds into another qualifying US property.
How To Report Capital Gains on a Tax Return
It is crucial to accurately report your income, which includes income from capital gains, on your tax return. Non-resident aliens generally use Form 1040NR to report their capital gains.
Regarding property, Form 1042-S Is used to report and pay the tax withheld. Income Codes 24, 25, and 26 must be used for transactions involving these entities. You should maintain detailed records of your transactions in case of an audit by the IRS.
Importance of Professional Tax Advice
You should seek professional tax advice when dealing with US tax law, especially if you are an NRA. A qualified tax advisor can analyze your situation, identify potential tax liabilities, and suggest ways to minimize your tax burden. They can also assist you in filing US tax returns and claiming applicable tax treaty benefits.
Additionally, they can help you stay on top of any changing tax laws or regulations that might impact you. That can include credit monitoring for potential tax liens placed by the IRS in case of errors or missed payments.
Remember that some states and localities may impose additional taxes on the sale of US property, even though this guide mainly focuses on federal capital gains tax. Additionally, NRAs selling US property may have information reporting obligations, even if they are not subject to capital gains tax. Consulting a tax professional can ensure that you comply with these requirements.
Keep the IRS Happy
It is crucial to comprehend the capital gains tax implications for Non-Resident Aliens (NRAs) while dealing with the sale of US property. You can handle the process more efficiently by getting yourself acquainted with FIRPTA, tax treaty benefits, and potential tax-saving strategies. However, it can be confusing. Therefore, it is wise to seek advice from a qualified tax professional. They can help you satisfy the IRS and optimize your tax outcome.
Contact us, and one of our customer champions will gladly help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.
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