Foreign Investment in U.S. Real Estate

PPVA vs. a “Blocker” Corp. Structure 

A sizable portion of the $350-500U.S. billion foreign inbound investment in the U.S. annually is placed in real estate. A Private Placement Variable Annuity (PPVA) can greatly reduce taxation and reporting requirements on these investments. The PPVA structure outlined in this blog is superior to the usual blocker corporation structure.

For the main points in this blog, we are indebted to Gerald Nowotny, a U.S. attorney, who writes frequently on Private Placement Life Insurance (PPLI) and PPVA topics. Mr. Nowotny’s recent article on PPVAs,“It Do Me Good!”  is our source.

According to Mr. Nowotny, the PPVA structure accomplishes several important tax and non-tax objectives:

  • “Avoidance of the need on the part of the foreign investor to file a U.S. income tax return and falling under the scrutiny and jurisdiction of the IRS.

 

  • Recharacterization of income that would be otherwise subject to taxation at the top corporate rates into interest and dividend income that is subject to lower tax rates under applicable tax treaties with the U.S.

 

 

  • Minimization of corporate taxation on the “blocker” corporation structure frequently used as part of this planning.”

Our blog is usually about the uses of PPLI structures for wealthy international families.  At times the use of a PPVA structure makes more sense, so we give you an example from Mr. Nowotny’s article to illustrate this point.

We have changed the example used in Mr. Nowotny’s article slightly, because we favor using offshore companies,who in this case, have made a 953(d) election. We have found that this results in more streamlined compliance reporting.

PPVA Structuring Example

Acme Investment Management is a real estate investment management organization investing in several different U.S. real estate markets. Acme creates an insurance dedicated fund (IDF) with the life insurance company, Corona Life, that will issue the annuity. We quote from the full article:

“Based upon the total premium (investment) commitment, Corona charges the policyholders 25 basis points per annum. The total cost per year is $250,000 per year. Over the course of the twenty year life of the fund-the total projected PPVA costs are $5 million. The total cost of the PPVA is roughly equal to the investor’s tax liabilities using the blocker corporation in the first 2-3 years.

The PPVA will not have any withholding for FIRPTA. Under the treaty, annuity income is not subject to U.S. income and withholding taxes. Therefore, neither Acme nor Corona will be required to withhold anything on its distribution.

Assume the same facts as the description above except for the fact, that the PPVA structure has no tax leakage. Corona does not have any withholding tax obligation on the income distributions of  any of the annuity payments or at liquidation of the investments. Corona is not subject to withholding under FIRPTA on the sale of the real estate.”

Please let us know how a PPVA structure can assist you in planning for the U.S. real estate investments of non-U.S. persons. We welcome your questions and comments.

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 by Michael Malloy, CLU TEP, @ Advanced Financial Solutions, Inc

 

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The Pythagorean Theorem Revisited

PPLI+ Tax Treaty2  = EWP2

International tax planning must combine items from various disciplines to achieve a successful result.  We will take liberties with the Pythagorean Theorem to make our point. Tax codes do not have the exactitude of mathematical formulas, but international families must frequently combine several elements to achieve the desired results. The elements we will discuss are Private Placement Life Insurance (PPLI), Expanded Worldwide Planning (EWP), and international tax treaties.  We will have a short refresher on the Pythagorean Theorem later on, but no quiz!

In the Pythagorean Theorem once two sides are known, you can solve for the third side using the Theorem.

We wish to solve for EWP, so let us explore how tax treaties allow us to achieve a successful result in solving our equation. At the heart of EWP is a properly structured PPLI policy. The assets inside this policy can be anything that can held by a trust company. These assets can also be located anywhere in the world.  While these assets are inside this PPLI policy, all tax is deferred.  At the death of the insured life/lives under the policy, these assets pass tax-free to the beneficiaries of the PPLI policy.

According to the Wikipedia Tax treaty page, “The stated goals for entering into a treaty often include reduction of double taxation, eliminating tax evasion, and encouraging cross-border trade efficiency. It is generally accepted that tax treaties improve certainty for taxpayers and tax authorities in their international dealings.”

At Advanced Financial Solutions, Inc., we research jurisdictions that give wealthy international families the most benefits.  Let us site an example of a Chinese family, who invests in U.S. real estate through a real estate investment advisor.  Depending on their estate planning needs, the investment advisor can create a new fund as a PPLI or a Private Placement Variable Annuity (PPVA). The policy will be owned by a foreign trust established by the family.

All of the real estate income and gains within the annuity contract will not be subject to taxation or withholding taxes under Article 17 of the U.S. –People’s Republic of China Income Tax Treaty.

Using EWP and PPLI we have provided this Chinese family, tax compliance, tax efficiency, simplified reporting, and enhanced privacy.

I know those of you who enjoy math have been waiting for the return of the Pythagorean Theorem.  Here it is in its most simple form courtesy of Margaret Patterson of Dr. Math:

So if you are told that you have a right triangle whose sides are 3 and 4,
like this:

|\
| \             Then you can use this theorem to find out what the
3 |  \ c          third side is.
|   \           3*3 + 4*4 = 9 + 16 = 25 = 5*5, so c=5
|____\
4

Our firm enjoys solving your problems, so please give us one that can be solved using EWP and PPLI. 

We appreciate your continued trust and support.

 

 by Michael Malloy, CLU TEP, @ Advanced Financial Solutions, Inc

 

 

 

 

Effective PPLI Real Estate Structures-2

Part II: Outstanding Results Realized

As we discussed in Part I, foreign Investment in-bound into the United States faces many hurdles and sometimes unforeseen costs.  An insurance solution using a specific life or annuity product can greatly simplify or eliminate many of these issues and make long term investing even more appealing.

All foreign Investors are exposed to a myriad of US tax consequences, including withholding taxes (30%), capital gains, and even U.S. Estate Taxes. Life insurance, and specifically Private Placement Life Insurance (PPLI), is a well-established tax and estate planning tool that many qualified investors utilize to mitigate and manage these exposures.

PPLI combines the well documented and compliant attributes of a standard life and annuity insurance product with a flexible investment platform. The flexibility includes a broad range of asset classes and employs qualifying Separately Managed Accounts (“SMAs”) or Insurance Dedicated Funds (“IDFs”).

Most structures can remain intact with the simple addition of a compliant life or annuity policy. PPLI can accommodate most custodians, managers or funds, making the transaction as simple to set up as a trust or other less effective structures.

PPLI also provides simplified reporting and confidentiality. The policy is reported once, and not the assets held or underlying investments. The owner reports a life policy and not that they are investors or hold assets in the U.S.

PPLI provides the same tax advantages of commercial life insurance:

  • Tax free or tax deferred growth of internal cash value
  • Tax free or tax deferred payment of death benefit
  • No capital gains taxes
  • No income taxes
  • Ability to access Cash Value through tax free loans
  • Ability to manage or mitigate estate taxes (if applicable)

The Summary Chart below compares using PPLI with other commonly used structures.  The small additional expense of adding PPLI to a structure gives the non-U.S. person many additional benefits that cannot be achieved otherwise.

Summary Chart

  Trust with LLC Dual Corporation Individual with LLC Insurance with IDF
Capital gains tax on gain 20% 35% 20% (if over $400,000, 15% if less) 0%
Medicate tax at 3.8% rate Not necessarily No No 0%
Files tax returns in personal name Not necessarily No, but need to disclose foreign shareholders and related party transaction Always No
Excess interest expense carries forward to offset gain from sale. Yes Yes Yes, but limited No
30% withholding tax on related party interest payments No Yes, unless treaty jurisdiction lender No No
Limits on deductibility of interest expense Yes (90%) Yes (60%) Yes (80%) No
Estate tax protection No Yes No Yes

 

Distribution creates additional withholding No Yes No No

 

Your comments and suggestions are always welcome!

Please contact us to find out if this type of structure is right for you.

 

  by Michael Malloy, CLU TEP, @ Advanced Financial Solutions, Inc