Japan RE - Minimizing Taxes while Building a Bigger Portfolio

12 Replies

Hi BP!  

I joined recently after hearing much about the forum.  I'm an American based in Japan, and finally decided to take the plunge as a personal investor a couple months ago and acquired a 14 unit residential building in Osaka.  Seems like there are quite a number of BP'ers based in Japan, so here goes my first post:

In the U.S., it seems like a 1031 exchange would one of the better methods for building a bigger portfolio while minimizing tax leakage, but it doesnt seem like Japan has such a tax deferment scheme with respect to investment property (but there is such a scheme for self-use residential property in Japan).  In Japan, I understand the capital gains tax to be 39% for ownership less than 5 years and 20% for ownership greater than 5 years.

1. Given the above, how are BP'ers in Japan building bigger portfolios while minimizing tax leakage on capital gains as properties are sold in order to acquire properties?    

2. Or, rather than selling, would it be better to continually refinance and use the proceeds to acquire more property?

3. At what point (in terms of portfolio asset value) would there be benefits to start engaging an accounting firm to structure Japanese legal entities to hold property?

Thanks!

From the situation you explained here and from what I know about real estate so far. Your best bet may be to hold it for a minimum of 5 years, refinancing so you can purchase more from year 1-5 and then after year 5, if you want out, sell it so you can minimize the taxation on your capital gain.

-That's probably what I would do in your situation anyway.

Originally posted by @Keen C. :

Hi BP!  

I joined recently after hearing much about the forum.  I'm an American based in Japan, and finally decided to take the plunge as a personal investor a couple months ago and acquired a 14 unit residential building in Osaka.  Seems like there are quite a number of BP'ers based in Japan, so here goes my first post:

In the U.S., it seems like a 1031 exchange would one of the better methods for building a bigger portfolio while minimizing tax leakage, but it doesnt seem like Japan has such a tax deferment scheme with respect to investment property (but there is such a scheme for self-use residential property in Japan).  In Japan, I understand the capital gains tax to be 39% for ownership less than 5 years and 20% for ownership greater than 5 years.

1. Given the above, how are BP'ers in Japan building bigger portfolios while minimizing tax leakage on capital gains as properties are sold in order to acquire properties?    

2. Or, rather than selling, would it be better to continually refinance and use the proceeds to acquire more property?

3. At what point (in terms of portfolio asset value) would there be benefits to start engaging an accounting firm to structure Japanese legal entities to hold property?

Thanks!

 Please see my message up above. Forgot to Mention you

Originally posted by @Dominic Jones :

From the situation you explained here and from what I know about real estate so far. Your best bet may be to hold it for a minimum of 5 years, refinancing so you can purchase more from year 1-5 and then after year 5, if you want out, sell it so you can minimize the taxation on your capital gain.

-That's probably what I would do in your situation anyway.

 Thanks Dominic; doesn't seem like there's a shortcut around the tried and true refinancing approach... seems like the U.S. is the only country that allows these 1031 exchanges!

Originally posted by @Keen C. :
Originally posted by @Dominic Jones:

From the situation you explained here and from what I know about real estate so far. Your best bet may be to hold it for a minimum of 5 years, refinancing so you can purchase more from year 1-5 and then after year 5, if you want out, sell it so you can minimize the taxation on your capital gain.

You are correct.  The U.S. is the only country that really has anything like the 1031 Exchange.  However, investors who sell foreign property that also creates a U.S. taxable event can structure a 1031 Exchange of foreign property as long as they want to reinvest in foreign property.  It would ONLY defer the U.S. taxable gain.  It does not have any impact on the foreign country tax consequences. We administer 1031 Exchanges of foreign property quite often, and it can work in most countries.  There are certain countries where the 1031 Exchange does not work due to their local laws, regulations and customs for closing real estate transactions. 

Originally posted by @Bill Exeter :
Originally posted by @Keen Chung Lo:
Originally posted by @Dominic Jones:

From the situation you explained here and from what I know about real estate so far. Your best bet may be to hold it for a minimum of 5 years, refinancing so you can purchase more from year 1-5 and then after year 5, if you want out, sell it so you can minimize the taxation on your capital gain.

You are correct.  The U.S. is the only country that really has anything like the 1031 Exchange.  However, investors who sell foreign property that also creates a U.S. taxable event can structure a 1031 Exchange of foreign property as long as they want to reinvest in foreign property.  It would ONLY defer the U.S. taxable gain.  It does not have any impact on the foreign country tax consequences. We administer 1031 Exchanges of foreign property quite often, and it can work in most countries.  There are certain countries where the 1031 Exchange does not work due to their local laws, regulations and customs for closing real estate transactions. 

Thanks Bill, didnt know that regarding 1031 Exchange for foreign properties!  

1. However, Japan already has a tax treaty with the U.S. which would allow the investor to avoid double taxation insofar as tax returns are correctly filed in both the U.S. and Japan? 

2. Thus, the 1031 Exchange of foreign properties seems like it would be utilized only if the foreign country where the foreign property is situated does not have a tax treaty with the U.S.?  

3. Bill, you tell me a bit more about which foreign countries your firm most regular encounters when administering such 1031 Exchanges of foreign properties?

Finally, I am in no way a tax expert, so please correct me if I am wrong on any of the above!

Originally posted by @Keen C. :

Thanks Bill, didnt know that regarding 1031 Exchange for foreign properties!  

1. However, Japan already has a tax treaty with the U.S. which would allow the investor to avoid double taxation insofar as tax returns are correctly filed in both the U.S. and Japan? 

Yes, they do have a tax treaty with the U.S., but what generally happens is that you compute the amount of U.S. taxes that would be due from the sale of the property in Japan and then you would receive a foreign tax credit for the amount of taxes paid in Japan against what you owe the U.S.  You would still owe U.S. taxes if the foreign tax credit is less than what you owe in the U.S.

2. Thus, the 1031 Exchange of foreign properties seems like it would be utilized only if the foreign country where the foreign property is situated does not have a tax treaty with the U.S.? 

No, see above.    

3. Bill, you tell me a bit more about which foreign countries your firm most regular encounters when administering such 1031 Exchanges of foreign properties?

We have administered 1031 Exchanges in about 40 different countries at this point in time.  The most frequent are: U.K., Canada, Australia, Canada and Mexico. 

Originally posted by @Bill Exeter :
Originally posted by @Keen Chung Lo:

Thanks Bill, didnt know that regarding 1031 Exchange for foreign properties!  

1. However, Japan already has a tax treaty with the U.S. which would allow the investor to avoid double taxation insofar as tax returns are correctly filed in both the U.S. and Japan? 

Yes, they do have a tax treaty with the U.S., but what generally happens is that you compute the amount of U.S. taxes that would be due from the sale of the property in Japan and then you would receive a foreign tax credit for the amount of taxes paid in Japan against what you owe the U.S.  You would still owe U.S. taxes if the foreign tax credit is less than what you owe in the U.S.

2. Thus, the 1031 Exchange of foreign properties seems like it would be utilized only if the foreign country where the foreign property is situated does not have a tax treaty with the U.S.? 

No, see above.    

3. Bill, you tell me a bit more about which foreign countries your firm most regular encounters when administering such 1031 Exchanges of foreign properties?

We have administered 1031 Exchanges in about 40 different countries at this point in time.  The most frequent are: U.K., Canada, Australia, Canada and Mexico. 

Thanks for all the great information that you've provided. Will definitely remember your name whenever I get to the 4 little house threshold and I want to exchange to one big house (monopoly reference) lol.

Great conversation has been had here. All great stuff for me to know as well since I'm planning on investing in foreign real estate and real estate on the home front. 

@Keen C.

Hi and welcome to BP! Kudos for taking the plunge with a large property. Just out of curiosity, what made you pick Osaka while living in Tokyo?

A couple of thoughts about your question

- To be honest, I wouldn't expect very rapid capital gains in Japan going forward, certainly nothing like the runup we've seen since 2009-2012 levels (assuming you aren't doing any kind of value add on the property). Of course if it happens - awesome!

- The name of the game seems to be cash flow using the arbitrage between OK returns and very cheap financing. I think 5 years is just about right for a time horizon to sell a property

- If you purchased with a 3.5-4.5% full loan via the usual suspects, you can usually refinance for a lower rate within a few years to increase your cash flow.

- If you put money down for a sub-2% rate, you're probably sitting pretty with cash flow anyway - why sell? Just reinvest the cashflow into more properties (but keep in mind the balance between liquidity, cash reserves, and capex events that you'll need to plan for on older buildings).

- Everyone I've talked to so far seems to think that a cash-out refi on an investment property isn't possible in Japan. I'm still not convinced it's completely out of the question, but it would probably take a very good relationship with your bank(s) and alot of patience.

- If you can still qualify for conventional loans in the US, you can use JP depreciation rules to offset alot of your JP tax burden. (Hint - wooden structure >22y/o is depreciated over 4.4 years. This applies to properties in the US too as long as you've been in Japan for over 5 years. If you can buy a property for 25% down but depreciate 100% of the value over 4.4 years, that's a pretty sweet deal.)

- Corporate structures can be used and are relatively inexpensive on the scale you're talking about. Well worth it for liability protection as well as you move into bigger buildings.

Would love to hear more about your specific deal if you're willing to share

BTW you might be interested in our monthly BP meetup happening right in your back yard - Brewdog in Roppongi. It's a great mix of experienced and newer folks, focusing both on JP and US investing. The next meetup is this week Thursday the 21st from 7pm, and you can see the details in this thread:

https://www.biggerpockets.com/forums/86/topics/204...

Best of luck in your investing!

-Dmitri

@Dmitri L. Thank you so much for the detailed response and apologies for the tardy reply.  Actually, had thought I'd followup with you at the meetup last week, unfortunate we didn't get to meet.

  • Osaka happened the way it did simply because it was a "packaged deal" sourced through the "usual suspects."  That said, the location wasn't bad since it was just 1 stop away from Umeda Station, within 3 mins of the closest station, and had a decent yield, so I just went for it.

Separately, have you (or any other BP'ers) looked into the below?

  • chintai heiyou juutaku 賃貸併用住宅 wherein you can obtain a personal housing mortgage loan at <100bps to build an apartment with multiple units on the condition that you live in the building and occupy greater than 50% of the area?
  • Acquiring a semi-occupied property with the intent to Airbnb the vacant units, either directly or through an Airbnb service provider (wherein they take 25%-33% of the Airbnb rent as a fee)?
Originally posted by @Keen C. :

@Dmitri L. Thank you so much for the detailed response and apologies for the tardy reply.  Actually, had thought I'd followup with you at the meetup last week, unfortunate we didn't get to meet.

  • Osaka happened the way it did simply because it was a "packaged deal" sourced through the "usual suspects."  That said, the location wasn't bad since it was just 1 stop away from Umeda Station, within 3 mins of the closest station, and had a decent yield, so I just went for it.

Separately, have you (or any other BP'ers) looked into the below?

  • chintai heiyou juutaku 賃貸併用住宅 wherein you can obtain a personal housing mortgage loan at <100bps to build an apartment with multiple units on the condition that you live in the building and occupy greater than 50% of the area?
  • Acquiring a semi-occupied property with the intent to Airbnb the vacant units, either directly or through an Airbnb service provider (wherein they take 25%-33% of the Airbnb rent as a fee)?

Keen let me know what the Airbnb stuff is all about. That's very interesting that they're beginning to change renting laws / regulations / policies in different countries with their power and influence growing so large!

Originally posted by @Keen C. :

@Dominic Jones

Hi Dominic, encourage you to have a read through the link below:

http://japanpropertycentral.com/2016/01/ota-ku-to-introduce-relaxed-letting-rules-from-today/

Thanks a lot, I'll give it a look over. I just sent you a connection request as well as a private message! Check it out when you have a moment.