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FIRPTA Episode 4: Single-Tier Holding Structures With No Estate Tax Risk

Portrait of Phil Hodgen

Phil Hodgen

Attorney, Principal


The “Real Estate Holding Structure” Series

This is the fourth episode of the real estate holding structure series. In this series I walk you through the thought process of a non-resident who wants to buy a home in the United States for personal or family use–not for rental.

  • ​Episode 1 - Thirteen single-level holding structures exist for possible use. (We’ll deal with multi-level holding structures later. Three are eliminated: forbidden, logically impossible, or wildly impractical.
  • ​Episode 2 - Of the ten remaining single-level holding structures, we eliminate three because they are guaranteed to result in estate tax if the real estate owner dies.
  • ​Episode 3 - Of the remaining seven holding structures, four have uncertain estate tax results. Some are more uncertain than others. Eliminate them: “maybe” means “no.”
  • This episode - of all of the single level structures we considered, three remain. All of them are guaranteed to prove estate tax protection.

In future episodes, I will consider multi-layer holding structures and test them for estate tax performance. Then we’ll get into income tax considerations, withholding problems, and who knows what else. I have no fixed agenda here, except to completely explore the question of “what’s the best holding structure for a home owned by a nonresident?”

Structures with no estate tax guaranteed

In the past three episodes we systematically rejected holding structures that definitely or potentially exposed our nonresident owner of U.S. real estate to estate tax.

We have three single-level holding structures left:

  • Foreign corporation owns the real estate and the nonresident owns all of the stock of the foreign corporation.
  • A well-crafted domestic irrevocable trust owns the real estate.
  • A well-crafted foreign irrevocable trust owns the real estate.

Let’s talk about WHY these structures prevent estate tax if the nonresident investor dies.

Why a foreign corporation structure prevents estate tax

Estate tax only happens when you have a dead person (“decedent”) and the dead person owned certain defined stuff (the “gross estate”).

A special definition exists for the “gross estate” of a nonresident-noncitizen of the United States: only property “situated in the United States” will be included.

“For the purpose of the tax imposed by section 2101, the value of the gross estate of every decedent nonresident not a citizen of the United States shall be that part of his gross estate (determined as provided in section 2031) which at the time of his death is situated in the United States.” IRC §2103, emphasis added.

The key to estate tax protection, for a nonresident-noncitizen, is to not own any property “situated in the United States.

Stock of a foreign corporation is considered to be situated outside the United States. Reg. §20.2105-1(f).

Thus, a nonresident-noncitizen who owns all of the stock of a foreign corporation holds an interest in property that is situated outside the United States – regardless of the assets owned by the corporation.

Irrevocable trust – foreign or domestic

Apply the same idea to an irrevocable trust: estate tax is imposed if the nonresident-noncitizen decedent had an “interest” in “property” “situated in the United States.”

A person can play one (or more) roles with a trust:

  • Settlor (i.e., someone who transferred assets to the trust);
  • Beneficiary (i.e., someone who can get assets from the trust); or
  • Trustee (i.e., the person who runs the whole operation).

Trustee - never

Trust assets may be owned by the trustee, but this is a formality only. The trustee is the “legal owner” but not the “beneficial owner.”

Thus, if the decedent is trustee of a trust, nothing is included in his or her gross estate.

Settlor - only if there is a “retained interest”

The nonresident-noncitizen transfers money to an irrevocable trust. The trust buys a house in the United States. The nonresident-noncitizen dies, achieving the dubious status of decedent.

Are the trust’s assets included in the gross estate of the decedent?

Yes, but only if the decedent had a “retained interest” in the trust assets.

Look at IRC §§2038, 2037, and 2038 – that is where retained interests are defined. You have control! Draft the trust document to eliminate retained interests, and the settlor will not have an interest (a “retained interest”) in the trust assets.

Beneficiary - only if there is a “general power of appointment”

Does a beneficiary have an “interest” in the trust assets? Only if the beneficiary has a power described in IRC §2041: a “general power of appointment.” If the beneficiary has the power to tell the trustee to distribute assets to himself, to his creditors, or to his estate, then the trust assets are included in the decedent’s gross estate.

A well-crafted trust document will not give the beneficiary a general power of appointment. The usual trust document will terminate the beneficiary’s rights at death – at which point other people become beneficiaries.

Remember that the estate tax is a transfer tax – an excise tax on the privilege of transferring property at death. If your beneficiary rights terminate when you die, then you don’t have anything you can transfer. A non-transfer. No tax.

Estate tax and single-level structures - conclusion

In conclusion, you have three single-level structures that will protect a nonresident-noncitizen of the United States from estate tax. Next time, I will start the analysis of multi-level structures. By adding complexity, we can increase the choices of structures that provide estate tax protection.

Having assured yourself of estate tax protection, how will you choose the right structure? By looking at other features: income tax performance, latent tax risks, withholding tax on sale, and cost/complexity to set up and operate.

Next time, I will explore some multi-level structures. There are a few instances where a defective single-level structure can be made to provide estate tax protection by adding a second layer.