International 1031 exchange – advanced tax planning for Americans selling investment property outside the United States
The United States taxes US citizens, residents and green card holders on their worldwide income, regardless of where they live. This includes the taxation on the sale of foreign real estate. This article explains how the 1031 rules can be used to avoid US taxation on such sales.
Monte Silver is a US tax attorney who specializes in solving high-value US tax matters where there is an international component. Silver & Co. exclusively represents US taxpayers and non-US taxpayers with regard to their US tax issues, including international 1031 exchanges.
For over thirty years, the law offices of Silver & Co. has specialized in providing high-value tax planning services for businesses and individuals outside the US who have US tax matters. Prior to founding the firm, Monte Silver worked at the Internal Revenue Service and at the U.S. Tax Court where he specialized in US taxation and tax litigation. Since founding his firm, Mr. Silver has focused is practice solely on representing clients outside the United States with regard to the high-value issues they face in the United States, or with the US authorities
What is an international 1031 exchange?
To understand what an international 1031 exchange is requires us to understand what an 1031 exchange is. A 1031 exchange is a situation where a US taxpayer (i) sells an old investment property for a profit, (i) uses the proceeds to buy a new investment property, where the (iii) profit from the sale of the old property is exempt from US tax.
In other words, a 1031 exchange is a situation where a taxpayer sells an investment property for a profit but pays no US taxes on the profit so long as the proceeds from the sale are rolled over to purchase a new investment property.
An international 1031 exchange is a simply 1031 exchange where both the old and new investment properties are located outside the United States.
Why is the 1031 exchange important?
Consider the following example: You are a US citizen or green card holder residing in either Hong Kong or Israel. Assume you own an investment property in that country that has greatly appreciated in value. You now want to sell the property and use the money to buy a new investment property in that country. Assume that the profit from the sale is either (i) exempt from tax in Hong Kong (or Israel), or (ii) subject to very low tax in that country.
The problem is that the sale is not exempt from taxes in the US. As a result, you will pay 20% US capital gains tax and 3.8% Net Investment Income Tax on the sale. If you reside in the US, you will also pay local state tax on the gain – an additional 10% if you live in California or New York. The result? Between 23.8% or 30% US tax, even though the sale is exempt from taxes in the country where the property is located. And if the profit is $1,000,000, that is at least $250,000 in US taxes down the drain.
This is where the 1031 exchange comes into play. If the sale and purchase of the investment properties is done correctly, ZERO US taxes will be due!!! In other words, tax savings of between $250,000/$300,000 per million dollars of profit.
If the potential for tax savings are so significant, why do so few taxpayers use the international 1031 exchange?
Why do so few people know about the international 1031 exchange, or use it?
Our firm, on the other hand, is made up of US tax experts who place a premium on identifying the high-value problems of our clients, and solving these problems effectively with out risk. The international 1031 exchange is one example. Our firm has vast experience in international 1031 exchanges. We utilize our expertise to implement such exchanges risk free, and save our clients vast amounts of money in US taxes.
Core issues in international 1031 exchanges
You sell an old investment property, get the money, and then buy a new investment property with all that money. In such a situation, you will not be entitled to tax free 1031 exchange.
On the other hand, what happens if you: (i) you sell the old property for $2,000,000, (ii) have $1,000,000 of that money directly transferred to a “1031 exchange trustee who uses the money to buy a new investment property, and (iii) take home $1,000,000 of the profit? In such case, assuming all the other 1031 rules are followed, you will only pay US tax on the $1,000,000 you take home. The $1,000,000 used to buy a new property is not subject to US tax.
To summarize, an International 1031 exchange can save a US taxpayer vast amounts of money. However, very few professionals understand how the international 1031 exchange works.
If you are a US taxpayer and are considering selling a non-US investment property and then buying another non-US investment property, contact us to discuss your options.