Do any of you have foreign investors in your deals? Or are you a foreign investor thinking about investing passively in a US real estate partnership? Do you know what happens when foreign investors invest passively in a US real estate deal? If the deal is not structured right, the result is not good at all. . .
When foreigners invest in US investment deals, the US government’s foremost concern is getting its tax dollars out of them.
It’s afraid that the investor will send the money overseas and the government will never see a penny.
So, the government does something really onerous.
It requires the partnership to withhold 20%-40% of the revenues attributable to the investor and pay them to the IRS. (The exact amount depends on the tax treaty between the US and the investor’s country.)
Not 20%-40% of the profits due to the foreign investor. Twenty to forty percent of the REVENUES – that’s BEFORE any expenses are taken out.
If your foreign investor owns a big enough piece of the deal, that could wipe out ALL your free cash flow!
It could crush your liquidity in the deal, and make it hard to operate the property!
AND, the government imposes the obligation on the partnership, so if you don’t do the withholding, the partnership will be liable for it.
So, what do you do?
How do you avoid being liable to the government for this money?
How do you avoid your investor being angry at you because you are sending all their money to the government?
The answer is a “blocker.”
A blocker is a US entity (an LLC or Inc., owned by the foreign investor, that actually invests in your deal.
As a US entity, the blocker has a US tax ID and the obligation to file US tax returns.
It also has the obligation to do withholding at the tax treaty rate.
HOWEVER, because the blocker’s revenues are the PROFITS of the investment partnership, all the expense deductions have been taken already!
The withholding is on a much smaller amount of money and your investor is happy.
To make this work, the blocker must be formed in the US, have a valid tax ID and have a local agent for service. Many law firms will perform this service for a small fee.
And that’s how you avoid massive unfair taxation on foreign investors!