The Complete Tax Planning Guide For Foreign Real Estate Investors

Foreign investors generally have the same goal of minimizing their tax liabilities from their U.S. real estate, as do their U.S. counterparts, although their objective is complicated by the very fact that they are not domiciled in the U.S. The U.S. has a special estate and gift tax regime that is applicable to foreign investors that are not domiciled in the U.S. This article summarizes the basic income tax, estate and gift tax issues that affect foreign investors investing in the U.S. This article also discusses how some foreign investors may be able to utilize U.S. income, estate and gift tax liabilities associated with investing in domestic real estate.

The Foreign Real Estate Investor: U.S. Income Tax and U.S. Transfer Tax Considerations

Foreign real estate investment often requires a balancing of U.S. income tax considerations on the one hand and U.S. gift and estate tax considerations on the other. With proper planning, foreign real estate investors can pay the same tax rates as U.S. investors. As a result, the income tax consequences are typically not a major consideration for foreign real estate investors. However, the U.S. estate and gift tax burdens are significantly higher for foreign real estate investors compared to U.S. real estate investors. It is for this reason, estate and gift tax planning is the main focus of planning for foreign real estate investors. Before going into the different types of planning options available to foreign real estate investors, it is important for the foreign investor to have a basic understanding of U.S. income tax, U.S. estate tax, and U.S. gift tax.

An Overview of the U.S. Income Tax System

The United States taxes the worldwide income of U.S. citizens and residents, regardless where they reside or are domiciled. The way U.S. taxes nonresidents that invest in the United States depends generally on whether income derives from U.S. sources and whether the income that is taxed derives from the conduct of a U.S. trade or business or from passive investment arrangements. As a general rule, a nonresident alien or foreign corporation that conducts a U.S. trade or business will be subject to the usual individual or corporate rates. Most forms of U.S.-source income received by foreign investors that is not effectively connected with a trade or business will be subject to a flat 30 percent tax on the gross amount of income received. This tax is sometimes referred to as FDAP and the FDAP tax can potentially be reduced or eliminated through a number of U.S. income tax treaties.

Foreign investors must also understand the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”). FIRPTA discussed in Section 897 of the Internal Revenue Code. Section 987 provides that nonresident individuals and foreign corporations are subject to U.S. tax on the gain recognized with a sale or disposition of a United States real estate interest as if such gain were U.S. source income and effectively connected with a U.S. trade or business. Under the FIRPTA rules, the buyer of real estate from a foreign individual or foreign corporation must typically withhold 15 percent of the sales price of the sale of U.S. real estate and pay the withholding tax to the Internal Revenue Service (“IRS”).

Unless a foreign investor intends to spend a significant amount of time in the U.S. or become a permanent resident of the United States, they will not be taxed on their worldwide income. However, a foreign investor may be subject to the U.S. income tax or FDAP tax on their U.S. real estate investment and any rental income they may receive from their U.S. real estate investment.

An Overview of the Estate and Gift Tax

U.S. federal law imposes a transfer tax upon the privilege of transferring property by gift, bequest, or inheritance. During an individual’s lifetime, this transfer tax takes the form of a gift tax. For gift tax purposes, a gift is defined as the transfer of property for less than adequate and full consideration in money or money’s worth, other than a transfer in the “ordinary course of business.” No U.S. gift tax would be owed on a gift to a beneficiary until the gifts made to the beneficiary in a calendar year exceed an applicable exclusion amount for that year ($19,000 for calendar year 2026). Upon an individual’s death, the tax takes the form of an estate tax. The tax is measured against a tax base that includes all the assets owned at death.

The U.S. estate and gift tax is assessed at a rate of 18 to 40 percent of the value of an estate or gift. A unified credit is available to minimize the impact of the transfer tax. The unified credit gives a set dollar amount that an individual can gift during their lifetime and pass on to the beneficiaries before a gift or estate tax applies. U.S. citizens and resident individuals are permitted a unified credit that exempt $15 million (for the 2026 calendar year) to their heirs without being assessed a gift or estate tax. The unified credit is significantly smaller for foreign individuals that are not domiciled in the U.S. The current unified credit for non-domiciliaries is equivalent to a $60,000 exemption, unless an applicable treaty allows a greater credit. In addition to its smaller size, the unified credit available to non-U.S. citizens and non-U.S. domiciliaries cannot be used to reduce their U.S. gift tax. The credit can only be used by their estates upon their deaths to reduce U.S. estate tax.

There are also significant differences as to how the estate and gift tax is calculated for individuals domiciled in the U.S. compared to individuals not domiciled in the U.S. The worldwide estate of a decedent is subject to U.S. estate tax only if the individual was either a U.S. citizen or resident at the time of death. In contrast, the estate of a non-U.S. citizen not domiciled in the U.S. is subject to estate tax solely on his or her U.S. situs assets. Situs is determined by the physical location of real property. Consequently, real property located in the United States is U.S. situs property for estate tax purposes. Stock of a U.S. corporation or partnership interest is U.S. situs. Stock of a foreign corporation or partnership interest is foreign situs, regardless of the place of management or location of stock certificates or units.

Similarly, all property gifted by a U.S. citizen or domiciliary is subject to U.S. gift tax regardless of where the property is situated. However, in the case of a donor who is neither a U.S. person nor a U.S. domiciliary, only gifts or real property or tangible personal property situated in the U.S. are subject to U.S. gift tax. The definition of tangible property does not include stock or partnership interest in a U.S. or foreign corporation or partnership even if such property may be included in a U.S. gross estate for federal estate tax purposes.

Determining Domicile for U.S. Estate and Gift Tax

Because individuals domiciled in the U.S. are permitted a unified credit of $15 million, for most U.S. citizens, the estate and gift tax is not an issue. This situation is different for foreign persons who are not domiciled in the U.S. Instead of a unified credit that would shelter up to $15 million in lifetime gifts, individuals not domiciled in the U.S. are only provided a credit equivalent to an exemption of just $60,000 against the estate tax. Given the differences in the way the U.S. estate and gift tax is calculated, it is crucial to understand when an individual can be classified as being domiciled in the United States. An individual is presumed to have a foreign domicile until such domicile is shown to have changed to a U.S. domicile. A person acquires a U.S. domicile by living in the United States, potentially even for a brief period of time, with no definite present intention of leaving. To be domiciled in the United States, for estate and gift tax purposes, an individual must be physically present in the U.S. coupled with the intent to remain in the U.S. indefinitely or permanently. For U.S. estate and gift tax purposes, an individual can be domiciled in one country. The term “domicile” for estate and gift tax purposes should not be confused with the terms “resident” or “residence” used in the income tax context. A foreign investor may be characterized as a resident of the U.S. for income tax purposes through either the green card test or substantial presence test. Just because a foreign person is classified as a U.S. resident for U.S. federal income tax purposes, does not mean the individual is domiciled in the U.S. for estate and gift tax purposes.

How the Estate Tax and Gift Tax is Computed for a Decedent Not Domiciled in the U.S.

The estate tax for a decedent that was not domiciled in the U.S. is only assessed on its gross estate. The gross estate is made up of property or assets situated in one of the U.S. states or the District of Columbia at the time of death. This is often referred to as U.S. situs assets or property. The gross estate is composed of revocable transfers taking effect at death, transfers with retained life interest, or (to a limited extent) transfers within three years of death are includible in the U.S. gross estate if the subject property was U.S. situs property at either the time of the transfer or the time of death. In the case of corporate stock, the stock of a U.S. is U.S. situs and stock of a foreign corporation is foreign situs, regardless of place of management or location of stock certificates.

The rules for determining gift tax for an individual not domiciled in the U.S. differ from the estate tax. As a general rule, the gift tax applies only if the transfers of tangible property (real property and tangible personal property, including currency) are physically located in the United States at the time of the gift. The gift tax does not apply to intangible property such as stock in U.S. or foreign corporations even though such property may be includible in the U.S. gross estate for federal estate tax purposes. Since the gift tax is not assessed on the transfer of securities, non-domiciliaries often transfer securities prior to death for planning purposes.

Overview of Structuring Alternatives to Hold U.S. Real Property or U.S. Businesses for Estate and Gift Tax Planning

We will now discuss various ways foreign investors who are not domiciled in the U.S. may hold U.S. assets. In particular, this article will look at the estate and gift tax consequences of holding U.S. real estate in a corporate structure, partnership, or trust. We will begin by examining the estate and gift tax consequences of the foreign investor directly holding a U.S. real estate. The simplest estate and gift tax planning option available to a foreign investor is to own real property directly and sell the asset before he or she dies. In many cases, this type of planning is not realistic due to the fact it is impossible to predict one’s demise. However, in some cases direct ownership of U.S. real estate by a non-U.S. domiciliary may be appropriate because of the availability of an estate tax and gift treaty. In other cases, the foreign investor can purchase lift insurance which can be utilized to satisfy the U.S. estate tax should the foreign investor unexpectedly die.

Holding U.S. Assets through a Foreign Corporation

Historically, foreign investors have made their direct investments in the U.S. principally through corporate ownership structures. Frequently, a foreign corporation was used as either the direct investment owner or as a holding company for a U.S. subsidiary (which, in turn, owned the direct U.S. real property). Individual foreign investors have frequently preferred use of corporate structures to avoid the U.S. estate and gift tax. Holding U.S. property through a foreign corporation will typically enable the foreign investor to avoid U.S. estate and gift tax because shares in a foreign corporation are not U.S. situs assets. Done properly, holding U.S. real estate through a foreign corporation will avoid the U.S. estate and gift tax. However, there are consequences associated with holding U.S. real estate through a foreign corporation.

If the foreign corporation holds U.S. real estate that is being rented, the foreign corporation may be subject to a 30% FDAP withholding tax. Real estate rental income will likely be treated as a passive activity subject to the 30% withholding tax without the benefit of any deductions for property management fees, property taxes, utilities, or mortgage interest. Foreign investors holding rental property through a foreign corporation can make an election to opt out of the FDAP 30% withholding rules. Special withholding rules apply to foreign corporations that hold U.S. real property interests under Section 897 of the Internal Revenue Code. Under Section 897, foreign investors holding U.S. real estate through a foreign corporation can make an election under Section 882(d) to treat all its U.S. source income from real property as effectively connected to a U.S. trade or business. Making a Section 897 election will not only avoid the 30 percent withholding tax, the election will permit the foreign investor to offset his or her U.S. tax on rental income through deductions associated with the rental of the property.

The foreign corporation will also likely need to file U.S. income tax returns and Form 5472 with the IRS annually.

A foreign corporate structure should be carefully considered when utilized as part of an estate plan in any case where there are U.S. beneficiaries. This is because a U.S. beneficiary may receive shares of a foreign corporation that will either become a controlled foreign corporation (“CFC”) if one or more U.S. persons constructively,  indirectly or directly owns 10-percent or more of the shares of the entity or a passive foreign investment company or PFIC. U.S. persons holding shares of a CFC may be subject to “Net CFC Tested Income (“NCTI”) or Subpart F tax regimes. U.S. heirs that inherit shares of a CFC will need to annually file a Form 5471 with the IRS. The Form 5471 is one of the most complicated reporting obligations in the U.S. offshore information tax reporting regime.

In the case of a foreign corporate share classified as a PFIC, U.S. persons owning shares in the PFIC must pay U.S. tax plus an interest charge based on the value of any tax deferral at the time the shareholder disposes of the PFIC stock at a gain or receives an “excess distribution” from the PFIC.  An excess distribution includes the following: 1) a gain realized on the sale of PFIC stock; and 2) any actual distribution made by the PFIC, but only to the extent the total actual distribution received by the shareholder for the year exceeds 125 percent of the average actual distribution received by the shareholder in the preceding three years. The amount of an excess distribution is treated as if it had been realized pro rata over the holding period of the foreign share and, therefore, the tax due on an excess distribution is the sum of the deferred yearly tax amounts. This is computed by using the highest tax rate in effect in the years the income was accumulated, plus interest.  As a result of these complex and punitive tax rules, a U.S. heir of a corporation often receives a “cursed inheritance.”

There are other U.S. tax consequences that must be considered before placing an asset into a foreign corporation, particularly U.S. real estate. If a shareholder makes use of a home for personal reasons that is placed in a foreign corporation, any increases in value of the home will not qualify for an exclusion of gains under Section 121 of the Code. Internal Revenue Code Section 121 allows a taxpayer to exclude up to $250,000 ($500,000 for certain taxpayers who file a joint return) of the gain from the sale of property owned as a principal residence for at least two of the five years before the sale.  Any increase in the value of the property that is reflected in an increase in the value of the shares may ultimately be subject to two layers of tax.

In some cases, holding U.S. real property through a foreign corporation can be an effective planning option for FIRPTA. Many income tax treaties between the United States and other countries have nondiscrimination clauses that prohibit the United States from treating a permanent establishment of a foreign corporation in the United States less favorably than domestic corporations carrying on the same activities.  Section 897(i) permits a foreign corporation having a permanent establishment in the United States that is protected by a nondiscrimination clause in a tax treaty to elect to be treated as a U.S. corporation for purposes of 897 and 1445 FIRPTA withholding requirements. One potential result of such an election would be that the sale of real property by the electing foreign corporation may potentially not involve Section 897.

Holding U.S. Assets through a Domestic Corporation

Given the disadvantages of placing U.S. assets in a foreign corporation, foreign investors may consider contributing U.S. assets to a domestic corporation. From a U.S. income tax point of view, a U.S. corporation will avoid some of the harsh tax consequences discussed above.

There are a number of other income tax consequences that must be considered before placing a U.S. asset into a domestic corporation. This is particularly the case when U.S. real estate is transferred to a domestic corporation. If a foreign investor is a shareholder of a domestic corporation and makes use of the real property held by the domestic corporation for personal reasons, the IRS may impute taxable rental income from the domestic corporation to the foreign investor. If the real property placed into the domestic corporation is a primary residence, and if the real property increases in value, the appreciation will not qualify for a Section 121 exemption.  As a result, any increase in the value of real property held as a primary residence will be taxed. In addition, rental income may be subject to 30 percent FDAP withholding tax. However, as discussed above, an election may be made under Section 897 of the Internal Revenue Code to eliminate the withholding tax. Another disadvantage of holding U.S. property through a foreign corporation is that the structure is subject to two layers of tax; one layer at the shareholder level and a second layer at the corporate level.

Foreign investors that hold U.S. real estate through a domestic corporation will likely need to file U.S. tax returns and a Form 5472 with the IRS annually.

FIRPTA withholding tax may be required by a U.S. corporation U.S. real estate. The FIRPTA withholding tax may potentially be avoided if on the disposition of an interest in a U.S. corporation the corporation furnishes an affidavit to the IRS stating that it is not and has not been a U.S. real property holding corporation during the five-year or shorter year period.

In certain cases, a domestic corporation can be an effective tool for gift tax planning. Recall that the U.S. federal gift tax applies to non-domiciliaries when they make transfers of tangible property physically located in the U.S. at the time of the gift. Thus, the gift tax may not apply when domestic stocks are transferred through a gift. However, a domestic corporate structure holding U.S. real property will not offer any protection for the U.S. estate tax to the foreign investor.

Holding U.S. Real Property through a Multi-Tiered Blocker Structure

Many foreign investors investing in U.S. real property are advised to hold property through multi-tiered structures. These structures usually result in a foreign corporation holding the stock of a U.S. corporation that holds U.S. real estate. This structure has a number of advantages such as the possibility of avoiding federal tax on the sale of foreign corporate stock. However, there is a potential significant disadvantage to utilizing a multi-tiered blocker structure for purposes of holding U.S. real property.

Prior to 2004, multi-tiered corporate structures could be utilized to protect foreign investors from the U.S. federal estate and gift tax.This is no longer the case. All this was possible because prior to 2004, a U.S. corporation was able to reincorporate in a foreign jurisdiction and thereby replace the U.S. parent corporation with a foreign parent corporation. These transactions were commonly referred to as asset inversion transactions. In asset inversions, a U.S. corporation generally recognized gain (but not loss) under Section 367(a) of the Internal Revenue Code as though it had sold all of its assets, but the shareholders generally did not recognize gain or loss, assuming the transaction met the requirements of a reorganization under Section 368. To remove the incentive to engage in corporate inversion transactions, Congress included several provisions in the 2004 JOBS Act aimed at corporate inversions. One of these provisions was Section 7874 to the Internal Revenue Code. The anti-inversion rules are designed to prevent corporate inversions by providing different methods of taxation depending on whether the former U.S. shareholders own at least 80 percent of the new foreign corporation or at least 60 percent (but less than 80 percent) of the shares of a new foreign corporation.

With a multi-tier structure, at the death of the foreign investor, the domestic corporation is typically merged into the foreign parent corporation. The very act of the domestic corporation merging into the foreign corporate parent can trigger the anti-inversion rules of Section 7874. Triggering the anti-inversion rules would mean that the foreign parent corporation would be treated as a U.S. corporation for U.S. tax purposes. Classifying the foreign parent corporation as a U.S. corporation means that the multi-tiered structure likely offers no protection from the U.S. estate tax.

Holding U.S. Assets through a Partnership

Foreign investors often overlook utilizing partnerships as a structure to hold U.S. real estate. The use of a partnership (regardless of whether it is domestic or foreign, general or limited) has the very significant advantage of enabling the individual foreign investor not to be subject to two layers of tax (as with corporate structures). The extent to which the U.S. estate tax rules apply to partnerships and other pass-through entities held by foreign investors are not totally free from doubt. There is at least some risk that the IRS might assert that a partnership holding a U.S. asset is a U.S. situs asset for purposes of the U.S. estate tax, regardless of whether it is a domestic or foreign partnership.

However, if a partnership holding U.S. real estate formed in a jurisdiction outside the United States is more likely not to be classified as U.S. situs property for purposes of U.S. estate tax. For income tax purposes, the Internal Revenue Code adopts an aggregate approach to partnerships for some purposes and an entity approach for other purposes. For example, under the aggregate approach, a partnership is treated as a conduit which passes income through to the partners to be reported on their individual returns. A partnership is considered an entity, however, for purposes of determining the amount, character, and timing of partnership items. Unlike corporations, partnerships are typically only subject to one layer of tax and as a result, the partners of a partnership are taxed more favorably than shareholders of C corporations. However, foreign partners of U.S. partnerships are subject to a complex set of withholding rules that must be considered when utilizing a partnership to hold U.S. real property.

Ownership of U.S. Property through a Trust

Many foreign investors believe they can hold U.S. real property through a revocable trust to avoid the U.S. estate and gift tax. Holding U.S. real property through a revocable trust provides no protection from the U.S. estate or gift tax. A foreign investor may hold U.S. property in an irrevocable trust. The trust can be domestic of foreign. An irrevocable trust is potentially an attractive vehicle for newly acquired U.S. real property or a U.S. business as long as there are no U.S. beneficiaries (i.e., a U.S. citizen or resident) of the trust. If the foreign investor has potential U.S. beneficiaries that could receive the U.S. property held in trust, holding U.S. real property in an irrevocable trust, especially a foreign irrevocable trust is typically not recommended. This is because a U.S. beneficiary of a foreign irrevocable trust could be subject to an extremely negative tax known as a throw-back tax.

Introduction to Estate and Gift Tax Treaties

In some cases, foreign investors can utilize an estate and gift tax treaty to eliminate the U.S. estate and gift tax. The U.S. currently has treaties with 15 countries regarding estate, gift, or generation-skipping transfer tax. Some of the transfer tax treaties provide for more beneficial deductions, such as marital deduction and charitable deduction, or a larger exemption from estate tax than otherwise would apply to a non domiciliary of the United States.

The U.S. has entered into treaties with Finland, Greece, Ireland, Italy, the Netherlands, South Africa, and Switzerland that cover only estate taxes. The U.S. has treaties with Australia and Japan that cover estate and gift taxes. The U.S. has treaties with Austria, Denmark, France, Germany, and the United Kingdom that cover estate, gift, and generation-skipping transfer taxes. The U.S- Canada income tax treaty substantially modifies the U.S. estate tax for Canadian citizens and residents.

Changes to Domicile under Certain Treaty Provisions

Domicile is determined under the internal laws of the treaty partner’s country under the U.S. treaties with Australia, Finland, Greece, Ireland, Italy, Japan, South Africa, and Switzerland. However, U.S. treaties with Germany, Netherlands, United Kingdom, France, Denmark, and Austria, a series of tests apply. In these treaties, typically, if an individual is viewed by both treaty countries as a domiciliary of both countries, he or she will be classified as a domiciliary of the treaty country of which he or she is a citizen if he or she has resided in the other treaty country for fewer than 7 of the 10 or 5 of 7 years prior to the transfer of the property in question. If this domiciliary test cannot be utilized, domicile can be determined in order by reviewing the following: 1) permanent home of the individual; 2) center of vital interests of the individual; 3) habitual abode of the individual; citizenship; or mutual agreement of the taxing authorities. Each treaty must be carefully reviewed to determine the domicile of the individual at issue.

Sometimes a foreign investor can utilize an estate and gift tax treaty to avoid a U.S. estate tax.

The three illustrations below show how each of the U.S.-U.K., U.S.-Canada, and U.S.-Germany treaties may be utilized to eliminate the U.S. estate tax.

Illustration 1.

Let’s assume a United Kingdom domiciliary dies while owning U.S. real estate valued at $125,000. Since the U.K. domiciliary died owning U.S. situs property worth more than $60,000, the U.K domiciliary’s estate would typically be subject to the U.S. estate tax. However, Article 8, paragraph 5 of the U.S.-U.K. estate, gift, and generation-skipping tax treaty states “Where property may be taxed in the United States on the death of a United Kingdom national who was neither domiciled in nor a national of the United States and a claim is made under this paragraph, the tax imposed in the United States shall be limited to the amount of tax which would have been imposed had the decedent become domiciled in the United States immediately before his death, on the property which would in that event have been taxable.”

In order to determine if the estate of a U.K. domiciliary owes a U.S. estate tax, it will be necessary review the decedent’s worldwide assets at the date of death and calculate a hypothetical estate tax on the decedent’s worldwide assets as if the decedent were domiciled in the U.S. In this example, let’s assume that the U.K. domiciliary owed U.K. assets valued at $1,356,939 which she died in 2023. Since she owed U.S. situs assets valued at $125,000, the U.K. domiciliaries total worldwide estate was valued at $1,481,939. The estate tax exemption in 2023 is $12.92 million. The U.S. assets comprised 16% of the total worldwide assets ($125,000/$1,356,939). Under the estate tax treaty between the U.S. and the U.K., the estate is able to take a pro rata credit of $2,007,520. The estate tax on $1,481,939 is approximately $592,775 ($1,481,939 x 40% = $592,775) which is offset in full by the unified credit, leaving a U.S. estate tax of zero.

Illustration 2.

Let’s assume a Canadian domiciliary dies owning U.S. real estate valued in excess of $60,000. Similar to Illustration 1, the executor may file a U.S. estate tax return with an attached Form 8833 “Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)” citing Article XXIX B of the United States-Canada Income Tax Treaty. The purpose of Article XXIX B is to better coordinate the operation of the death tax regimes of the two countries. Such coordination is necessary because the U.S. imposes an estate tax, while Canada applies income tax on gains realized at death rather than an estate tax.

As with the U.S.-U.K. estate, gift, and generation skipping tax treaty, the U.S.-Canada income tax treaty permits a deceased Canadian domiciliary a pro-rata percentage of the same unified credit available to U.S domiciliaries. The resulting percentage is applied to the unified credit for the year of death. This amount is the maximum unified credit allowed, which is limited to the actual amount of tax.

Illustration 3.

For this example, let’s assume a husband and wife were domiciled in Germany. They decided to acquire U.S. real estate in the resort town of Park City, Utah. Husband died when the U.S. real property had a fair market value of $5,000,000. Let’s assume that the Park City real estate was the only asset the couple held on the date of the husband’s death.

The executor of the deceased German domiciliary husband may utilize the U.S.-German estate, gift, and generation skipping tax treaty reduce the estate’s exposure to the U.S. estate tax.Under the U.S.-German estate, gift, and generation-skipping tax treaty, for purposes of determining the estate tax, “the taxable base is to the extent by its value (after taking into consideration any applicable deductions) exceeds 50% of the value of all property.”

Under Article 10, Paragraph 4, for purposes of determining the U.S. estate tax for the estate of the deceased German husband, 50% of the value of the property passed to the surviving spouse is not subject to the U.S. estate tax (this will be discussed in more detail below). In determining the estate tax imposed by the United States, Article 10, Paragraph 5 provides that if a decedent was domiciled in Germany at the time of the decedent’s death, the estate tax shall be allowed a unified credit equal to the greater of: a) the amount that bears the same ratio to the credit allowed to the estate of the citizen of the United States as to the value of the part of the decedent’s gross estate that at the time of the decedent’s death is situated in the United States bears to the value of the decedent’s entire gross estate wherever situated; or b) the unified credit allowed to the estate of a nonresident not a citizen of the United States. Under Article 10, Paragraph 5 of the treaty, the estate of the husband is allowed a unified credit of $12.92 million against the estate tax.

The U.S. estates of individuals domiciled in Australia, Finland, France, Greece, Japan, and Switzerland are also entitled to utilize a proportion of the applicable unified credit amount otherwise available only to the estates of U.S. citizens and U.S. domiciliaries.

Treaties and the Marital Deduction

U.S. tax law, U.S. allows an unlimited deduction for property passing from a decedent to his or her surviving spouse. Referred to as the unlimited marital deduction (or “UMD”), this deduction is the most important deduction available to married couples wishing to minimize transfer taxes on their property. The UMD excludes from U.S. estate and gift taxes all the property transferred by one spouse to another. However, in order to take the UMD, the spouse receiving the transferred property must be a U.S. citizen. Whether or not the receiving spouse is domiciled in the U.S. is irrelevant for purposes of this deduction.

In the case of gifts made to a spouse who is not a U.S. citizen, the annual gift tax exclusion amount is increased from $19,000 to $194,000 (for calendar year 2026). In the case of passing property upon the death to a surviving spouse who is not a U.S. citizen, the UMD can be available if the property is transferred to a qualified domestic trust or (“QDOT”). The QDOT arrangement allows the estate to postpone payment of the decedent’s estate tax, generally until the surviving spouse’s death. The postponed tax is imposed on the QDOT property revalued at the time of taxation at the decedent’s top marginal estate tax rate and the property held in the QDOT is taxed as if it had been included in the decedent’s gross estate.

There are a number of treaties that abrogate these rules. For example, the United Kingdom estate, gift, and generation-skipping tax treaties provide for an unlimited marital deduction for property which would have been eligible for such a deduction had the decedent been domiciled in the U.S. at his death.

The United States-United Kingdom Estate, Gift, and Generation-Skipping Tax Treaty and the Marital Deduction

The United Kingdom’s estate and gift tax treaties with the United States provide for a UMD which would have been eligible for such a deduction had the decedent been domiciled in the U.S. at his death. Under these treaties, individuals domiciled in Denmark or the United Kingdom can claim a UMD for purposes of U.S. estate or gift taxes as if they were domiciled in the United States. This offers a significant planning opportunity for mitigating the consequences of the U.S. estate and gift tax. In essence, the United Kingdom estate, gift, and generation-skipping tax treaty exempts most if not all U.S. situs assets from the U.S. estate and gift tax in connection with interspousal transfers. That is, as long as the worldwide assets of the transferor U.K. domiciled spouse does not exceed the applicable unified credit ($15 million for 2026).

United States-German Estate, Gift, and Generation Skipping TaxTreaty

Under the U.S.-German estate, gift, and generation-skipping tax treaty, interspousal transfers are excluded from a qualifying decedent’s gross estate for U.S. estate tax purposes to the extent that their value does not exceed 50 percent of the value of all property included in the U.S. taxable base. This marital deduction is limited to the amount that would reduce the U.S. estate tax due to what would apply to U.S. citizens or resident aliens. Under the wording of the United States-German estate, gift, and generation-skipping tax treaty, the estate would then be subject to U.S. tax in the lower amount of a) the figure determined using the marital deduction; or b) that generally imposed upon nonresident aliens under U.S. law. In general, the treaty provides the following benefits to foreign investors that are residents of Germany:

1. The estate of a German domiciliary may claim a proportion of U.S. estate unified credit based upon the respective values of the decedent’s U.S. gross estate and his worldwide gross estate.

2. An estate of a German domiciliary is entitled to a marital deduction equal to the value of any “qualified property” passing to the decedent’s surviving spouse so long as such amount would qualify for the U.S. estate marital deduction if the surviving spouse were a U.S. citizen and all applicable elections were properly made, providing that: a) At the time of the decedent’s death, both the decedent and the surviving spouse were domiciled in either the U.S. or Germany; b) If the decedent and the surviving spouse were at the time both U.S. domiciliaries and one or both of them were German citizens; and c) The executor of the decedent’s estate elects to use the marital deduction treaty benefits and irrevocably waives the right to make a QDOT election on behalf of the estate.To illustrate how the marital deduction is applied, the Treasury Department has provided a number of examples in the Treasury Department’s Technical Explanation to the protocol governing estate tax in the United States-German estate, gift, and generation-skipping tax treaty illustrates the operation of the pro rata unified credit and marital deduction. The examples provided by the Treasury Department provide as follows: for purposes of these examples, presume that: 1) H (the decedent) and W (his surviving spouse) are German citizen residents in Germany at the time of the decedent’s death; 2) H died in 2016, when the Section 2010 unified credit was $2,125,800 and the related applicable exclusion amount was $5,450,000; 3) the conditions set forth in the Protocol are satisfied; 4) no deductions are available under the Internal Revenue Code in comparing the U.S. estate tax liability.
   

   Example 1.

   (i) H has U.S. real property worth $10,000,000, all of which he bequeaths to W. The remainder of H’s estate consists of $10,000,000 of German situs property.

   (ii) Pursuant to the existing marital deduction provision of the Germany Treaty [Article 10(4), as modified by the Germany Protocol], the U.S. gross estate equals $5,000,000 [the amount by which the $10,000,000 of U.S. real estate bequeathed to W exceeds $5,000,000 (50 percent of the total value of U.S. property taxable by the United States under the Germany Treaty)]. H’s worldwide gross estate equals $15,000,000 ($5,000,000 plus $10,000,000 of German situs property).

   (iii) The $5,000,000 U.S. gross estate is reduced by the $2,500,000 marital deduction of Germany Treaty Article 10(6), resulting in a $2,500,000 U.S. taxable estate. The tentative tax on the taxable estate equals $945,800. H’s estate would also be entitled to the pro rata unified credit allowed by Germany Treaty Article 10(5) of $708,600 [$2,125,800 (the full 2016 unified credit) x $5,000,000/$15,000,000 (the $5,000,000 U.S. gross estate divided by the $15,000,000 worldwide gross estate)]. Thus, the total U.S. estate liability is approximately $237,200 ($945,800 – $708,600 = $237,200).

   Example 2.

   (i) The facts are the same as in Example 1 except that H bequests $1,000,000 of his real property to W and $9,000,000 of his real property to C, H’s child.

   (ii) The $9,000,000 of U.S. real property bequeathed to C is included in H’s U.S. gross estate. Pursuant to the U.S.-Germany Treaty Article 10(4), none of the U.S. real property bequeathed to W is included in the gross estate because such property would be included only to the extent its value (i.e., $1,000,000) exceeded 50 percent of the $10,000,000 total U.S. situs property taxable under the applicable provisions of the Germany Treaty. H’s worldwide gross estate equals $19,000,000 ($9,000,000 plus $10,000,000 of German situs property).

   (iii) Because none of the U.S. situs property bequeathed to W is included in the U.S. gross estate, the property is not “qualifying property,” and therefore no marital deduction is allowed with respect to that property under Germany Tax Treaty Article 10(6). The tentative tax on the $9,000,000 gross estate equals $3,545,800. H’s estate would also be entitled to the pro rata unified credit allowed by Germany Treaty Article 10(5), which equals approximately [$2,125,800 (the full 2016 unified credit), multiplied by a fraction equal to the $9,000,000 U.S. gross estate over the $19,000,000 worldwide gross estate. Thus, the total U.S. estate tax liability is $2,538,843 ($3,545,800- $1,006,957).

   The United States- Canada Income Tax Treaty

   The U.S.- Canada income tax tax treaty provides relief from the U.S. estate tax. (However, the treaty does not provide any relief from the U.S. gift tax). Some Canadian investors in the U.S. are also able to enjoy an estate tax marital deduction. The U.S.- Canada income tax treaty provisions relevant to the U.S. estate tax and marital deduction may be summarized through the following examples:

Illustration 1.

Justine Lieber owns a vacation home in Florida with a value of $10,000,000, unencumbered by a mortgage. His other worldwide assets amount to U.S. $1,000,000. There will be no U.S. estate tax whether or not Justine Lieber is survived by his spouse.
This is because Canadian citizens who die owning U.S. assets are entitled to a credit against his or her U.S. estate tax liability in an amount equal to that proportion of the U.S. unified credit as his U.S. situated estate would apply to his worldwide estate.

Below, please see Illustration 2. which provides a more detailed discussion as to how the U.S.-Canadian income tax treaty operates.

Illustration 2.

Bryan Bosling, a Canadian resident, owns vacation homes in California and Hawaii with a value of $10,900,000, unencumbered by mortgage, and Canadian property valued at $10,900,000. If Bryan Bosling died, his estate, for U.S. estate tax purposes would be entitled to a credit of U.S. $4,417,800 [the U.S. $4,417,800 (for proration of unified credit for 2018) “unified credit” x [(U.S. assets)/(Worldwide assets) ($10,900,000 + $10,900,000 = $21,800,000]. U.S. Worldwide Assets x $4,417,800 unified credit (2018) = $96,308  Bryan Bosling’s estate tax will be U.S. $96,308 unless Bryan Bosling is married and makes a qualifying transfer to a QDOT. Instead of relying on the rule that allows a deduction for bequests by a Canadian resident to a non-U.S. citizen spouse provided assets are timely transferred to a QDOT, the U.S. will allow an election to be made for an additional nonrefundable marital credit up to the amount of the proportionate credit.

How Certain Treaties Abrogate the Situs Rules

Only the U.S. situs assets of non-U.S. domiciliaries are subject to the estate tax. A number of estate and gift tax treaties abrogate the usual situs rules for purposes of estate and gift taxation.

Under Article 9 of the estate tax treaty provides that only Germany may tax tangible personal property such as cash, debt obligations, and U.S. corporate stock owned by a Germany domiciliary. The treaty completely removes cash, debt obligations, and corporate stock from U.S. situs for purposes of U.S. estate and gift tax. As a result of the U.S.-German tax treaty, an individual domiciled in Germany may hold shares of U.S. stock free from U.S. estate tax. The same rules do not apply to U.S. partnership interests.

Under Article 8 of the treaty, if a German domiciliary operates a U.S. partnership that has either business property or a permanent establishment in the United States, the value of the partnership will be subject to U.S. estate tax.

The U.S. estate tax treaties with the United Kingdom, Austria, France, Denmark, and the Netherlands contain similar provisions. However, the United Kingdom and Austria estate tax treaties do not contain specific provisions regarding partnerships. Article 8 of the U.S.- France estate, gift, and generation-skipping tax treaty has its own unique provisions governing corporate stock, debt obligations, and other intangible property that changes the situs rules. Under Article 8 of the treaty, “only France should tax shares or stock in a corporation, debt obligations (whether or not there is written evidence thereof), other intangible property, and currency” owned by a decedent domiciled in France.”

A careful analysis should be done with applicable treaties in order to determine how the treaty may abrogate the U.S. situs rules and to determine how such abrogations may impact planning for a foreign investor.

Conclusion

This article is intended to acquaint readers with some of the principal U.S. estate and gift tax considerations that can come into play when investors who are not U.S. citizens or residents invest in real estate in the United States. This area is relatively complex and is constantly evolving with Congress entertaining new tax laws, the IRS issuing new regulations and interpretations and courts rendering new rulings in this area. As a result, it is crucial that non-U.S. investors consult with a qualified international tax attorney when planning to invest in U.S. real estate.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.