News
June 6, 2007

The Three 'Ts' Of Purchasing Real Estate Abroad

Arnold & Porter Advisory

By Ellen Kaye Fleishhacker

People generally have a variety of motivations for buying real estate in foreign countries - ranging from investment potential to the desire to have a vacation home abroad or a place for a child to live while he or she studies or works in a foreign locale. Whatever the motivation for purchasing the property, we have identified a number of issues that arise again and again in real estate transactions in foreign countries in an effort to shed light on some potential obstacles. We call them the three 'Ts' of purchasing real estate abroad.

Title Issues

When buying real estate abroad, it is crucial that you obtain assurances that you will have clear title to and the right to unencumbered possession of the real estate. However, it is much more difficult to obtain these assurances in foreign countries than it is in the United States. First, the United States has one of the most sophisticated systems of land registration in the world; therefore when buying property abroad there is more inherent risk that there are gaps in or problems with title. Additionally, because boundaries all over the world have shifted due to wars and political changes, there are often basic questions regarding ownership. In many countries, you can work with a notary to verify legal documents and try to make sense of title. However, a notary is not an insurer of title, and if he or she is wrong, generally your only recourse is to sue him or her and prove negligence. Even in countries where title is guaranteed by the government, there is often a lengthy and costly procedure before a claim can be paid. Additionally, government title guarantees generally do not cover against such issues as easements and adverse possession (i.e., rights of others across the property or squatters on the property). For these reasons, we strongly advise our clients to purchase a policy of international title insurance whenever they buy real property abroad.

Tax Issues

There are a variety of tax issues to consider when you buy real property abroad. First, will there be local transfer, recordation or real property taxes due? These taxes often have different names, but the same result (i.e., the need to pay additional sums to governmental entities incident to the privilege of owning property in the foreign locale). You will need to consult with a local attorney or other specialist in the country in which you are purchasing the property to answer this question. Additionally, if you decide to rent out your property, you will be required to report rental income on your U.S. tax return (and possibly also do the same in the country in which the property is located). You may receive a foreign tax credit against your U.S. tax bill if you pay tax on the rental income in the country in which the property is located. However, in some cases, you could be obligated to pay tax on that income in both countries. If you decide to sell the foreign property, the capital gains taxes in some countries can be as high as 40%; and, in cases in which the U.S. foreign tax credit may be inapplicable, you may be obligated to pay capital gains taxes in both the country in which the property is located and the United States. You should also consider whether the property will be included in your U.S. estate in the event of your death, or if the foreign country will divide it among your heirs pursuant to its local laws. In most cases, for information about your own specific situation, it is prudent to consult with an international tax specialist before purchasing real estate abroad.

Traps

This category is probably the most difficult to pin down because it varies from country to country. As a general rule, however, some traps to beware of include:

  • Foreign-Ownership Laws: In some countries, foreigners do not have the legal right to own property. For example, Mexico's constitution prohibits foreigners from owning property within 30 miles of the coastline or 60 miles of the U.S. border. Therefore, foreigners must own such land in Mexico through trusts, called "fideicomisos."
  • Uncertain Legal Rights: You do not want to invest money in a property in a country that is unstable. Additionally, there is always the risk in some countries that the government will not respect your property rights, and will seize your property, or that you will need to resolve issues in potentially biased foreign courts.
  • Structure: It is normally preferable to own your foreign property through the equivalent of an LLC. In Scotland, for example, if one holds title as an individual at the date of death, then there may be significant estate taxes. However, if one holds title through an LLC, then the estate tax risk disappears, because under Scottish law LLCs do not "die" Also, as in the U.S., the LLC structure generally offers protection from liability.
  • "Unusual" Documentation: The documentation of real estate transactions varies from country to country. In Mexico, most real estate transactions involve two contracts: the promissory agreement, which is a preliminary agreement containing only the most basic information, and the purchase sales agreement, which is the agreement by which title transfers to the buyer. You will need to familiarize yourself with the documentation used in the country in which you are buying the property, and should probably hire a local expert to assist you.

Conclusion

Buying real property abroad can be a frustrating and confusing experience, or a wonderfully rewarding experience. The difference between the two usually depends on advance research, preparation and consultation with appropriate advisors.

For more information, please contact:

Ellen Kaye Fleishhacker
415 677 6420
efleishhacker@howardrice.com

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