The Big Apple’s Big Appeal: 6 Reasons Foreigners Should Invest in NYC Real Estate
During the year ended March 2017, foreign investment in U.S. residential real estate increased by 49% to an all-time high of $153 billion. Foreign investors choose to invest in the United States for many reasons, including economic stability, a favorable legal climate, and the sheer variety of investment opportunities.
That diversity of options itself can make it difficult for foreign investors to settle on any one. To help narrow the field, international investors looking for a new opportunity should consider investing in New York City real estate for the following six reasons:
- Confidentiality of company ownership
- Privacy and security of financial information
- U.S. taxes don’t bite (with proper planning)
- Financing is available for foreigners
- A stable housing market
- A strong system of private property rights
Most investors prefer that their holdings remain confidential. This becomes an issue when purchasing real estate, because ownership records are public. To help protect their privacy, many investors purchase real property through a business entity. When doing so, the name of the entity—not the investor—is listed as owner in the public records.
However, in recent years a handful of nations have taken actions to eliminate the confidentiality provided by a business entity. The following countries either have or are considering a public registry of ultimate beneficial owners—the individuals who own or control a company, directly or indirectly:
- United Kingdom
- New Zealand
Additionally, the European Commission’s 4th Anti-Money Laundering Directive requires European Union members to establish a central registry of beneficial owners, which may or may not be made public. The Commission is currently considering an amendment to the Directive that would require those registries to be public.
The United States does not maintain such a registry. Some states require that the owners of a business entity be identified in the formation documents, which become public records. However, New York is not one of those states. By buying property through, e.g., a New York limited liability company, investors can expand their holdings while protecting their privacy.
Privacy and Security of Financial Information
Relatedly, 102 countries have adopted the Organisation for Economic Co-operation and Development’s Common Reporting Standard (CRS). Under the CRS, these nations will begin automatically sharing identifying information (such as name and tax ID) and financial information (such as financial account number and balance) about foreign investors.
More than half of the countries that have adopted the CRS began sharing information under the program in September 2017. These include:
- British Virgin Islands
- Cayman Islands
- Isle of Man
- United Kingdom
The remaining countries will begin sharing information in 2018, including:
- China (Hong Kong)
- The Bahamas
- Russian Federation
- United Arab Emirates
This automatic-sharing regime presents international investors with two potential problems: The first is that an investor’s home country may misuse the information it receives about the investor and his or her foreign property.
The second potential problem is that the systems for sharing information under the CRS are new and untested. Consequently, it is unclear whether the systems are secure enough to protect the information being shared from hackers or leaks.
The United States is the only major world economy that has not signed onto the CRS. Accordingly, it is not sharing such information with foreign investors’ home countries. In fact, in many cases it does not even collect the types of information that are shared under the CRS, making financial details about foreign investors more secure in the U.S. than elsewhere.
U.S. Taxes Don’t Bite (With Proper Planning)
Despite the advantages of investing in the United States, many foreigners are reluctant to do so because they believe that U.S. taxes are prohibitively high. However, this impression is only partially true. Yes, combined federal and New York income tax rates can be as high as 65%, but investors should keep two caveats to that figure in mind.
First, income taxes in the United States are imposed on net income, not gross income. State and federal laws permit property owners to deduct common expenses associated with renting or selling their property. Second, with proper planning, the total tax burden can be reduced or eliminated.
Minimizing Tax on Rental Income
For example, rental income is subject to tax by the U.S. and New York governments at a combined rate of up to 65%. But these taxes apply after expenses are deducted from gross rental income. Among many others, foreign owners can deduct the following expenses:
- Travel expenses when visiting the rental property, including airfare to the U.S. and living expenses while present in the U.S., such as the cost of housing, transportation, and meals.
- Insurance covering the rental property.
- Property taxes imposed on the rental property.
- Real estate professionals, such as brokers, real estate attorneys, real estate managers, or accountants.
In addition to such actual expenses, property owners can also take a deduction for depreciation, which is an annual allowance for the gradual deterioration of property. The amount of the deduction is determined using a formula and the property’s basis—generally, what the investor paid to acquire the property.
Example: A foreign investor owns a multifamily building that she purchased for $10 million in 2016, allocating $8.5 million to the building (which is depreciable) and $1.5 million to the underlying land (which is not depreciable). She earns $500,000 in rental income from the building each year. From that $500,000, she can deduct annual depreciation of $309,060.
Minimizing Tax on Sales Proceeds
Combined state and federal income taxes on sales proceeds can also be as high as 65%. However, these taxes can be deferred by what’s known as a 1031 exchange. In a 1031 exchange, the owner of property sells it and reinvests the sales proceeds in “like-kind” property. With real estate, this means that both the property sold and the property acquired must be real estate.
Other than that restriction, though, 1031 exchanges are quite flexible. For example, an investor who owns one piece of real property may sell it and acquire two. If an investor owns a development property, he or she may sell it for a different type of real estate. Residential real estate can be sold to acquire commercial real estate.
In a properly structured 1031 exchange, income taxes that would otherwise be due upon the sale of a property can be deferred until the later sale of the property acquired.
Example: A foreign investor sells a condominium for $1 million. Her basis in the condo is $600,000. If she keeps the money, she will owe income tax on her gain—$400,000. If she uses the proceeds to purchase two new condominiums for $500,000 each in a properly structure 1031 exchange, she will not owe income tax when she sells the first condo.
As an alternative to selling, an investor may also qualify for refinancing his or her New York property. Refinancing—taking out a loan secured by property the investor already owns—enables the investor to obtain up to 50% of the property’s value in cash tax-free. Additionally, interest paid on the loan will be deductible from income generated by the property.
Financing is Available for Foreigners
That last point raises another common misconception among foreign investors—that U.S. banks do not offer financing to foreigners. In fact, U.S. banks are willing to finance foreign customers’ U.S. investments, although they often impose more restrictions on such borrowers than on their domestic customers.
For example, a bank may limit the amount that a foreign investor can borrow, or require that he or she maintain a certain amount of money on deposit with the bank while the loan is outstanding.
A Stable Housing Market
The housing market in New York City is more stable than that in other parts of the United States. For instance, although the recent housing crash did impact the luxury real estate market in New York City, average-priced homes in prime areas were barely affected. In addition, New York City home prices were relatively quick to recover after the crash. Some areas of the U.S.—such as Las Vegas, Miami, and Phoenix—have yet to recover.
A Strong System of Property Rights
Both the New York and U.S. constitutions provide strong protections for private property rights. Although the government does have the power of “eminent domain,” under which it may take private property in some circumstances, that power is not akin to simple confiscation. Rather, it is subject to three important limitations.
First, when the government exercises its eminent-domain power, it must pay the owner the fair market value (FMV) of the property it takes. FMV is measured objectively: It is the price that a willing buyer and willing seller would agree to, neither being under compulsion to buy or sell. If the government tries to pay less than FMV, the owner can challenge it in court.
Second, the government is only permitted to take private property for a public purpose. It cannot seize the property arbitrarily, to injure a disfavored owner, or to enrich a politically connected individual. Again, the owner can challenge the government’s actions if he or she believes the taking does not meet this standard.
Finally, the government must follow a lengthy, formal procedure to exercise its power of eminent domain. As has been noted, this procedure includes the possibility of challenge by the property’s owner all along the way.
New York City real estate remains a top choice for international investors for several reasons. Foreign investors considering new opportunities in the United States should carefully weigh their options by assessing the above advantages in terms of their own interests and investment goals.
Those interested in learning more about buying real estate in New York should contact the experienced attorneys of Dilendorf Khurdayan for more information.