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Born Out of the U.S.A.? Welcome to the Federal Gift and Estate Tax

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Many foreign persons moving to the United States are surprised to find out that the U.S. imposes an excise tax on gifts and decedent’s estates. Many countries in the world have no gift or estate tax. The tax on the gift or estate can be as high as 40%. Therefore, ignorance of the U.S. gift and estate tax rules can be detrimental to a foreign person’s financial health. As one IRS agent stated, “I am amazed that foreign persons make investments or move to the United States without consulting with a tax advisor.”

Often, upon arrival in the ‘Land of Opportunity,’ the first thing a foreign person will do is purchase a residence. Deciding how to take title to the newly acquired residence is extremely important from a gift and estate tax standpoint. With a married couple, the tendency will usually be to take title to the residence as joint owners. Generally, this means that the husband and wife both own an undivided 50% interest in the home. This can raise gift tax issues because if the source of funds used to purchase the home came solely from one spouse, a taxable gift may occur. Furthermore, because in other cultures it is not uncommon to frequently change title among owners, foreign persons may add or change title to siblings or children without realizing such changes are taxable gifts in the U.S. 

In a recent situation, a foreign couple invested in U.S. real estate because their child was moving to the U.S. to attend college and would perhaps remain in the U.S. after the child’s collegiate studies concluded. The real estate was titled as joint tenants with the parents and child. The father passed away unexpectedly, and, because the property was titled as joint tenants, the entire value of the property was presumed to be included in the father’s U.S. gross estate even though he only held a third of the interest.

What does this mean from a tax perspective? The mother and child had to prove that they contributed their own funds to the purchase of the residence as to not potentially be subject to an estate tax. In addition, since the child held one-third ownership of the residence, if the parents provided the funds for the purchase price, a taxable gift was likely made to the child upon the purchase of the home. 

When consulting with a U.S. tax advisor about estate planning, a foreign person, regardless of how long he or she has lived in the U.S., must clearly explain they are not a U.S. citizen. Why is this critical? For U.S. citizens and foreign persons domiciled in the U.S., the exemption amount before the gift or estate tax will apply is $5.25 million. However, a foreign person who is not domiciled in the U.S. has only a $60,000 exemption for estate tax and no exemption for gift tax. Knowing whether you are considered a non-U.S. citizen or a foreign person domiciled in the U.S. comes down to this: a person is domiciled in the U.S. if they are physically present in the U.S. with the intent to remain in the U.S. indefinitely.

Because of these lower exemption amounts, the IRS may argue that a foreign person is not domiciled in the U.S. so the U.S. can collect more taxes on the U.S. assets. 

Another trap for non-citizens in the U.S. is that there is normally no gift or estate tax for assets transferred from one spouse to another. However, this exception, called the unlimited marital deduction, does not apply to non-U.S. citizens unless a special U.S. trust called a qualified domestic trust (often referred to as a “QDOT”) has been established. The QDOT can only be used to defer the estate tax until the death of the surviving spouse. It cannot be used for deferral of gift tax. 

For good reasons, U.S. trust and estate attorneys prefer to use trusts, such as a QDOT, for clients’ life time planning and also at death. Many countries in the world, however, do not recognize trusts. 

Therefore, it is important to take a holistic approach to your estate planning. There are three key tenets to follow if you are a foreign person with assets in the U.S. and other countries. First, make sure you are asking the right questions; second, work with an informed and knowledgeable tax professional; and third, collaborate with those other countries to coordinate a worldwide plan. 

Material discussed is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs.


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