Many people are subject to US capital gains taxes on the sale of their foreign property. These folks may be surprised to discover that the US government collects taxes on income from many sources. This is true, even if the income is derived from the sale of foreign property. United States taxpayers (including non-citizen US residents) are required to report their earned income and file tax returns no matter where they derive their income.
1031 Exchange Stops at the Border
An investor seeking to exchange into the United States, may be more surprised to learn that in order to qualify for tax deferral under Section 1031, the exchange must be of “like-kind property”; and, that in 1031(h), Congress wrote the law so that “property located in the United States and property located outside the United States is NOT considered to be “like kind.”
Deferred Sales Trusts Alternative
Deferred Sales Trusts (also called DSTs) are a tax efficient alternative (to 1031 exchanges) for deferring capital gain taxes for both US and foreign property. DST arrangements are akin to an “installment sale” or “seller carry-back financing,” but without the risk of the buyer defaulting. This is because in a DST, an institutional trust takes the sale proceeds from the buyer at the time of closing of the sale of the property; and, this eliminates the risk of the buyer failing to fully perform or to make timely payments.
Deferred Sales Trusts operate under Internal Revenue Code Section 453 just like other installment sales made directly with a buyer. However, the following exceptions apply.
In a DST, the first requirement is that a written trust agreement must be negotiated between the seller and an institutional trustee (such as a large bank or trust company) in order to administer the seller’s sale proceeds.
Next, the property is conveyed to the institutional trustee in exchange for an installment agreement. The trust becomes obligated to make predetermined fixed-installment payments to the seller over time according to the terms of the installment agreement. This installment agreement can be drafted to suit the client’s specific investment goals and income needs.
In the final step, the trust actually sells the property to the Buyer; and, thereafter uses these proceeds to make the payments to the seller. In addition, the seller also accrues interest while the funds are held in the trust account.
Saving Money in Taxes Is Not a Foreign Concept
US capital gains taxes can be partially or fully tax deferred over the term of the installment agreement created within the Deferred Sales Trust account; and best of all, this works for property located outside of the United States.
This has just been a very simple overview. Deferred Sales Trusts are governed by a complicated set of tax rules. You really need to work with experienced Deferred Sales Trust administrators as well as your own tax and legal advisers to make sure you follow the rules and regulations properly.
- 1031 Hotline: If you have questions about 1031 boundaries with foreign properties, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
© 2016 Jeffrey R. Peterson – All Rights Reserved