US real estate investment via a Limited Liability Company

Many Australian investors have acquired real estate investments in the United States in recent years and in most cases they have been advised to do so via the use of a limited liability company (LLC).

It is our understanding that under the United States LLC Act, an LLC is not required to issue shares, its ‘owners’ are called members and it appears that sole membership of a LLC is permitted. The LLC is a separate legal entity and a body corporate. When an entity becomes a member of the LLC it acquires the associated interest, called a limited liability company interest (LLC interest), which represents the member’s share of the LLC’s profits and losses and the member’s right to receive distributions of the LLC’s assets.

From a taxation perspective it appears that a LLC is a ‘fiscally transparent’ entity for US Federal tax purposes. That is, the LLC itself is not taxed but rather the members of the LLC are taxed on the income derived by the LLC in proportion to their LLC interest holding.

Australian income tax and capital gains tax

Under the general rules a LLC is a company for Australian tax purposes as it is a body corporate. However, the Australian tax law provides for special taxation treatment of certain “foreign hybrid” entities.

The rules provide for foreign hybrids, that are treated as flow-through entities for the purposes of foreign tax, but treated as companies for Australian income tax purposes, to be treated as partnerships for the income tax and capital gains tax (CGT) purposes. The expression ‘foreign hybrid’ is defined to mean a foreign hybrid limited partnership or a foreign hybrid company.

The requirements for a company to qualify as a foreign hybrid company are:

  • At all times during the income year the company is treated as a partnership under the country’s foreign tax law and the company satisfies any regulations relating to that treatment.
  • At no time during the income year is the company a resident of any foreign country for the purposes of a law of the foreign country which imposes foreign tax on entities because they are residents of that foreign country.
  • The company is not an Australian resident at any time during the income year.

Disregarding Division 830, the foreign company is a CFC in relation to another taxpayer at the end of a statutory accounting period that ends in the relevant income year and, at the end of the statutory accounting period, the taxpayer is an attributable taxpayer in relation to the CFC with an attribution percentage of greater than nil.

A company formed in the US will be a foreign hybrid company if it satisfies each of the 4 conditions set out above. However, it will also be a foreign hybrid company if it satisfies conditions 2 to 4 above and for the purposes of US income tax law it is a limited liability company that:

  1. is treated as a partnership; or
  2. is an eligible entity that is disregarded as an entity separate from its owner.

On the basis the LLC meets the above conditions the members of the LLC are regarded as partners for Australian tax purposes. Income of the LLC is therefore assessed to the members and any foreign income tax paid by the members is allowed as a foreign income tax offset (FITO) in the members Australian tax assessment.

Where a LLC has acquired US property, any subsequent disposal of the property will be subject to Australian CGT on the basis the members have disposed of the property in their own right.

The double tax agreement (DTA) we have with the US provides that income and profits from real property may be taxed in the US. Where this is the case the Australian resident members will also be assessed in Australia but will receive a FITO for the US tax paid.

Should clients approach you in regards to establishing a LLC in the Unites States the following ATO rulings and Interpretative Decisions make a very useful reference:

Ruling 1

Interpretative Decision 1

Interpretative Decision 2

Interpretative Decision 3

Note: Through our PrimeGlobal membership, we are able to liaise with US PrimeGlobal member firms on your behalf or introduce you to US accounting firms that may be able to provide direct assistance on the US side of the border.

This article provides a general summary of the subject covered as at the date it is published. It cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

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