Home Sweet Home Or A House Of Cards?

Tax Planning Considerations for the Purchase of a Residence in the U.S. by Foreign Buyers

Overview

In spite of its many problems as a nation, the quality of life and level of economic opportunity as well as the overall respect for the rule of law, places the United States in a very unique position when compared to the rest of the World. The proof of my thesis – how many people have come to the U.S. legally and illegally for the last 150 years versus the rest of the world? Central and South Americans and others are moving to the United States and not Beijing, Moscow or Outer Mongolia.

The combination of economic and political stability along with a stable currency and low inflation continue to make the United States a desirable final destination. These considerations – political and economic instability- are frequently short lived and uncertain in many parts of the world. Many non-Americans discovered this truth a long time ago. In many large metropolitan areas of the U.S., wealthy individuals and their families can live without personal scrutiny and threat to their personal freedom and security.

Many foreigners purchase a personal residence as an investment and a safe haven from their own countries in the pursuit of their own version of life, liberty and the pursuit of happiness on American soil. In many cases, foreigners send their children to college in the U.S. with the children frequently remaining in the U.S. after graduation for a number of years. As home financing is less available in many countries when compared to the U.S., many foreigners purchase the residence outright. As a result and by definition, these foreigners have substantial assets in the U.S. for tax purposes.

Traditionally, the tax structuring for wealthy foreigners in regard to the purchase of a U.S. personal residence has focused on federal estate tax planning considerations and not federal income taxation. As a practical matter, why would the homeowner worry about income taxation if there is no rental income associated with principal residence?

The 2012 Tax Court case of G.D. Parker, Inc. v. C.I.R. T.C. Memo 2012-327 (2012) is the proverbial "game changer" for this planning scenario and shifts the focus to income tax considerations. The case is a perfect example of what can go wrong.1

Genaro Delgado Parker is a very wealthy Peruvian who owned a large ocean front home in Key Biscayne. The taxpayer owned a Florida corporation which had a number of subsidiary companies including another Florida corporation which owned the Key Biscayne home. The shares of the holding company were owned by a Panamanian corporation. In this respect, the taxpayer did what a large number of foreign buyers have done when it comes to purchasing a personal residence.

The client and his family lived in the home rent-free for several years (2003-2005). The IRS disallowed deductions under IRC Sec 262 for repairs and maintenance and depreciation on the basis that these deductions were personal and family expenses and not business expenses. These expenses over a three year period averaged $125,000-$150,000 per year approximately. Further, the IRS treated the rent-free use of the house as a constructive dividend paid to the taxpayer through the corporate chain up to the taxpayer personally.

When a shareholder or his family is permitted to use corporate property for personal purposes, the fair rental value of the property is includable in his or her income as a constructive dividend to the extent of the corporation's earnings and profits.2 For a corporate benefit to be treated as a constructive dividend, the item must...