If you’re a UK resident British national looking to, or have invested in, US real estate and for US tax purposes you’re defined as a Non-Resident Alien (NRA), you should be aware of the tax implications. Here’s an overview of the potential tax consequences.

When owning US real estate, there are a number of considerations and taxes to bear in mind in order to ensure that you’re not caught out in the long run.

Take a look at this insight for the general concepts of Effectively Connected Income (ECI) and Fixed or Determinable Annual or Periodic (FDAP) income and an overview of the US taxation of NRAs. In summary, FDAP is generally passive income, taxable at a flat rate of 30% on gross receipts and it’s subject to withholding tax at source. ECI is subject to tax at graduated rates and is based on the net income, after taking deductions directly related to that income. Receipt of ECI will require the filing of a US tax return, Form 1040NR.

Rental income from US real estate

Rental income from US real estate can potentially be FDAP or ECI, depending on the situation. However, it’s often favourable to elect to treat the rental income as ECI so that deductions can be claimed against rental income, and this avoids a flat rate of 30% against the rental income. If you’re UK resident, the rental profits will also need to be declared on your UK tax return. However, you would be allowed to claim double tax relief for US Federal and State Income Tax due on the same profits.

The US allows a depreciation deduction to be taken against the rental income, which often reduces the taxable rental income to nil when you also account for other expenses such as interest, legal fees, accounting fees, repairs/maintenance, agent fees, etc. However, the UK does not allow for a depreciation deduction, so there’s often more profit that’s subject to tax on a UK tax return than on the US, and not sufficient double tax relief available to reduce the UK tax to nil.

Capital Gains Tax (CGT) on US real estate

Capital gains from the sale of US rental property is always ECI so you would need to file a tax return in this situation. Withholding tax on 15% on the sale proceeds should apply when you sell US real estate but there’s potential for withholding tax to be reduced. If you were to sell US real estate, the gain would also be taxable on your UK tax return. However, the US would have the primary taxing rights on a capital gain on US sourced real estate, so double tax relief would need to be claimed on the UK tax return. With US long term CGT rate being 20%, and the UK CGT rate on the sale of residential property being 28%, there might be a UK tax charge if there’s insufficient double tax relief. However, State Income Tax could increase the tax charge and fluctuation in the exchange rate needs to be considered.

When disposing of a property that was once rented out, the US also has a concept of depreciation recapture whereby the depreciation that was claimed, or could have been claimed on the rental property, may be taxable as income in the year the property is disposed of.

State tax should be considered if the property is located in a State which has an Income Tax regime (most do).

US Estate Tax on US real estate

US Estate Tax applies to US situs assets held by NRAs, which includes interests in US real estate. As an NRA, you only have a $60,000 exemption from US Estate Tax, and therefore many NRAs look into structuring their US real estate investments with a corporate blocker entity. This entity could be a US or foreign corporation, or could include a partnership or trust . If there’s a real estate business in place, you should seek professional advice to ensure you have the right structure in place. Also, in certain cases there could also be treaty exemptions available for some UK resident Brits, so structuring may not be desirable because there are other tax consequences to consider, depending on the structure used.

If you’re planning to leave your US real estate (which is valued over $60,000) to your spouse or anyone else in your will, you should consider Article 8(5) of the US/UK Estate Tax treaty. This article says that where property may be taxed in the US on the death of a UK national, who was neither domiciled or a national of the US, and a claim is made under this paragraph, the tax imposed in the US shall be limited to the amount of tax which would have been imposed had the decedent become domiciled in the US immediately before his death, on the property which would in that event have been taxable. A claim in this instance would be suitable for most UK nationals if their worldwide estate was less than the $12.92million limit (2023).

What should you do?

If you’re a UK resident British national who is looking to, or has invested in, US real estate, and for US tax purposes you’re defined as a Non-Resident Alien (NRA), you should review your tax liability and ensure you’re compliant.