It has been hard to find info regarding my situation, perhaps because it is a bit unique, and could use some help. My situation is as follows:
I am a foreign investor interested on purchasing a rental property in Cordova, Tennessee. I am a resident in Denmark, so my personal tax rates are astronomic. I have the option to invest with my parents, who live in a country with a much lower tax rate. The goal is to set up an investment structure that optimizes the level of taxation given the aforementioned context. This implies finding a structure exempt from TN's excise/franchise taxes, rendering inheritance taxes inapplicable when my parents pass away, and if possible, that my parents obtain the income from the rental property so that they end up paying taxes instead of me. It is hard to find info on the internet and to receive advice considering that what could apply to US citizens maybe does not apply in the same way to foreign investors. I have thought of some options, but fail to see which is the best:
1) I invest as the sole proprietor. As I understand, sole proprietors pay no franchise/excise taxes to TN (does this apply to foreigners?) I end up paying income taxes in Denmark from the rental income, which would ascend to 46% (I still can deduct what I pay in the US thanks to the double taxation agreement). But I spare any inheritance taxes. An umbrella policy would be purchased.
2) The contract is signed by my mother or father as the sole proprietor. Again no excise/franchise taxes I think. Since I am not the owner of the property, I pay no taxes either. However, the moment he or she passes away, I will have the burden of inheritance taxes, which as I understand, would be the 40% of the property's value minus $60k in the US as a foreigner. Plus I would have to probably pay that tax again in Denmark (not sure if that tax has a double taxation agreement). I would purchase umbrella policy to protect my assets.
3) I constitute an LLC where I am the sole member. As I understand, because of FONCE, I still pay no excise/franchise taxes since all income would be derived from the rental cash flows (100% passive income). However I am not sure whether this applies to foreigners. Then I would gift the income of the LLC to my parents. As I understand, if the gifts have a value of up to $15k (in 2018), then no taxes are paid. Again, I am not sure whether this applies to foreigners. In this case, after talking to an accountant in Denmark, I would not pay taxes here since it's the LLC who receives the income. At the same time, I would presumably pay no taxes from the gifts I would give to my parents since it will be for sure less than $15k a year. Also no inheritance tax since I am the member of the LLC owning the property. Would this arrangement work the way I am expecting it? Are there issues I have overlooked? No umbrella policy would be needed.
4) A multi member LLC is constituted. FONCE also determines that if the LLC is owned only by family members then it is still exempt from excise/franchise taxes. Again, not sure whether this applies to foreigners, and also not sure whether family relationships of father&mother&son are accepted. Here I have some ignorance regarding the functioning of multi member LLCs. Would it be possible that my parents get all the income from the LLC, they are taxed in their respective country, I am not taxed since I derive no income, but then when they pass away I pay no inheritance tax since I already was one of the members of the LLC? (so there was nothing to inherit to begin with) No umbrella policy would be necessary.
5) Any other structure that you think is better than the previous ones?
Lastly, If I 1st constitute a sole proprietorship, and then decide that an LLC or any other entity type was better, what would be the cost to change the entity type? What about changing the ownership? (from my to my mother for instance)
Ok I pretty much summed up all I have investigated so far. Right now it feels to me like a scrambled jigsaw puzzle and need help to connect all the dots. Sorry for a rather long post, but I have been overwhelmed with the complexity of the tax subject, and want to strike the best decision.
I will highly appreciate any insights. Thank you.
There are a lot of moving parts here... You should consult a US based tax CPA/EA who understands (1) Inbound Taxation as it relates to the US (2) Real Estate Taxation and (3) Tennessee F&E Tax. It might not also hurt to consult a US attorney on legal entity selection and state selection for organizing/incorporating, and a CPA/CA in your country and your parents country.
That said, you're not taking into consideration IRC Sec 1446 exposure with a MMLLC taxed as a partnership. I assume you know with a SMLLC that is disregarded for tax purposes you'd have a 1040NR with Sch E filing obligation. I would recommend speaking with an attorney before you forgo a legal entity just to save on the F&E tax.
An LLC taxed as a C Corp is another option. This would eliminate IRC Sec 1446 exposure. Favorable tax withholding rates on dividends might be achievable via tax treaties.
Tax treaties would need to be examined when considering estate taxes.
You may be eligible for the FONCE exemption. There are also exemptions for low income housing. Another easy one to qualify for is to become an OME (obligated member entity). To become an OME you file paperwork with the state to strip the LLC of its limited liability. I generally wouldn't recommend becoming an OME however just for the F&E exemption with an LLC that holds rental property. The risks outweigh the gain.
How do I know all of this? I was based in Memphis, TN before Atlanta.
Best of luck.
Thanks @Eamonn McElroy . Indeed, it has many moving parts and I have been overwhelmed by it. Regarding the IRC sections you mention, I will have a look at them, thank you.
After much reading on this topic, I am now inclined to having my parents constitute a common tenancy themselves, with 50-50 ownership, for reasons that I show below. They need to be verified by people with experience in the matter since it could be that this does not work as I am presenting it. If so, kindly let me know which of my assumptions are erroneous. Consider that we are all foreign investors investing only in a single residential rental property in Tennessee.
1) The common tenancy will be tax exempt from franchise and excise taxes because it is a unincorporated (general partnership) family owned entity deriving income wholly from passive real estate rental income.
2) When one of them dies, the 50% ownership in the partnership would be directly and automatically transferred to me in my condition of heirs, even if I am not part of the partnership and even if no Will was left. Though I am not sure whether the shares would pass along to the spouse or to me as heirs. How does this work in this case? It is important that it is passed to the heirs. Is a Will needed in this case?
Here I would have to pay Inheritance/Estate tax if the deceased's share in the partnership (i.e. 50%) surpasses the $60k threshold for foreign investors. In addition, I would become the new member of the common tenancy with my surviving parent, and we would own equally 50-50.
In addition since now I own 50% of the property through a common tenancy, I will be liable to taxes in my country of residence, Denmark, from the 50%, and not 100%, of the income generated by the rental property.
3) When my 2nd parent passes away, the same process is repeated. I would pay Inheritance/Estate taxes from the amount exceeding $60k of my 2nd parent's share in the partnership. By then I would become a sole proprietorship. Note that the $60k threshold is applied 2 times, once for each parent (is this valid?)
If you know of a better way of achieving my goals of minimizing the inheritance taxes and income taxes in Denmark, please let me know. The income tax rates of my parents' country of residence are lower compared to Denmark's.
Related question: is it a requirement to write a formal agreement detailing, among other things, the % shares of each member in the common tenancy? Otherwise how will the tax authorities know what is the ownership participation of each tenant, considering that common tenancies do not necessarily split the ownership equally?
I will highly appreciate your insights onto this subject.