Impact of State and Local Taxes on Foreign Investment in US Real Estate

January 27, 2010 Published Work
AFIRE Guide to US Real Estate Investing: Chapter 26

A foreign investor considering the tax implications of an investment in US real estate typically focuses on US federal income taxes and ignores state and local taxes. There are a number of reasons for this, first and foremost of which is that federal tax rates are substantially higher than those charged by states and localities. The maximum federal income tax rate applicable to corporate and individual investors is 35 percent. Moreover, corporations face a second level of tax applicable to distributions (or deemed distributions) to shareholders imposed at the rate of 30 percent unless reduced by tax treaty.
Most states and local income tax rates, on the other hand, are less than one-quarter of the federal rates. State taxes are also deductible in computing federal taxable income, making the effective rate lower still. However, taxes on net income are not the only taxes levied by state and local governments. Some states tax gross income and others tax a corporation's capital employed in the state.
While almost all states have sales and use taxes (the latter apply to the sale or use of tangible personal property in the state), some also tax various services. Some jurisdictions also impose a tax on rents paid with respect to real estate located within their boundaries. Another type of tax imposed by many states and some cities and counties is a real estate transfer or recording tax. This type of tax is typically expressed as a percentage of the consideration received in connection with a transfer of real estate. Finally, ad valorem real estate taxes are imposed against the value of real estate located within the jurisdictional limits of many state and local taxing authorities.