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The foreign fiduciary as global homeowner

 

Andréa Daley-Taylor and Catja Carrell highlight practical considerations for foreign fiduciaries holding real estate for US beneficiaries

Andréa Daley-Taylor is Director, and Catja Carrell is Legal Officer, at Trust Corporation International

What is the issue?

Holding international real estate for the benefit of US-connected beneficiaries is becoming ever-more challenging, given the increasing complexity of laws, regulations and compliance duties in the US and abroad.

What does this mean for me?

Trustees need to be mindful of US citizens within a beneficiary class. Some of the key challenges of holding real estate in trust are highlighted, including areas that might require specific attention.

What can I take away?

Holding real estate in trust presents its own challenges, but it is also worth considering the knock-on effects for your beneficiary class, especially if that includes US Persons.

In an increasingly globalised world with an increasingly mobile society, foreign fiduciaries are inevitably faced with the challenge of the US beneficiary. Transnational marriages, relocations or a beneficiary’s desire to attend a US university and then settling in the US are only a few of the reasons trustees may be confronted with new administrative and compliance duties under current US laws and regulations.

This article addresses some of the key challenges faced by foreign fiduciaries that hold or intend to purchase real estate either in or outside the US, for the benefit of US Person[1] beneficiaries. Although mired with complexities, it is certainly possible, with the appropriate insight and experience, for a single trustee to manage residential property in various jurisdictions for the benefit of US individuals.

Profiling the beneficiaries 

It is vital to take a close look at the class of beneficiaries – whether or not they are US Persons at the time of first contact – around whom decisions involving real estate may need to be framed. The relevant questions include:

While the beneficiaries should keep the trustees apprised of any changes to their residence status or nationality, even the most diligent know-your-client checks could see a US Person slip through the cracks (an ‘Accidental American’). This is why a general knowledge of the US regulatory landscape, federal income and transfer tax rules and planning options is helpful when confronted with the possibility of a US Person beneficiary living in the US and/or the trust holding real estate at any point in the future.

Tax considerations and real estate

After having profiled the beneficiaries (and before even getting to questions of ownership, as discussed below), trustees should have a general idea as to where the beneficiaries reside or intend to reside, in both the short and longer term. This allows for pre-planning.

Pre-planning is necessary as the foreign trustee must keep in mind not only the US federal (and possibly state) income tax rules, but also the US federal estate and gift tax and various reporting rules.

Take the following example, the ‘deemed benefit rule’, which applies to foreign trusts with US beneficiaries. A beneficiary might be a dual US-Swiss citizen who lives in Switzerland and studies at the University of Miami during the summer months; if the trust owns the Miami property in which the beneficiary stays, the US will treat her rent-free use of the property as a deemed distribution, to the extent there is DNI in the trust, of the fair market value (FMV) of the use.[3] Though previously the beneficiary may have not had to file a US state or federal income tax return because, as a student, her yearly income had remained below the minimum filing threshold, the rent-free use of the house could now have potential income tax consequences (based on the value of the use) and will require her to file Form 3520.[4]

In the reverse situation, a foreign national might come to stay in a trust-owned property in the US for an extended period of time. There is the risk that the beneficiary might be treated as a US Person for tax purposes (under the substantial presence test) and thus trigger the deemed distribution rule. In addition to the US federal (and possible state) income taxation rules that might apply to the beneficiary, the trustee will need to comply with US federal estate and gift taxation and annual reporting rules, including the preparation of Schedule K1 forms[5] for any US limited liability companies (LLCs) (other than single member LLCs) that hold real estate, Form 3520 and Form 8938[6] reporting, and the production of beneficiary statements.

There are various types of planning that can be put in place either to eliminate some of these potential issues or at least facilitate resolution. For example, trustees can hire an appraiser to determine the FMV of the use of each item of property (this could include a valuable piece of artwork in the property) and, to the extent there is available DNI in the trust, charge an amount equivalent to the DNI as ‘rent’ for the beneficiary’s use of the asset(s). Other options include holding the property through a US trust or domesticating the foreign trust to the US.  

As ever, the trustee will want to engage legal, tax and accountancy advisors in both the US and any other relevant jurisdiction before undertaking any restructuring, since solving the US angle may create issues elsewhere.

Deciding questions of ownership

Not only must the foreign trustees take into account the profile (e.g. citizenship, likely relocation to the US) of the beneficiaries, but they also need to contemplate how best to manage real estate located in different countries in light of the status of the beneficiaries under US law.

For instance, although countries like Switzerland and Hong Kong have ratified The Hague Trusts Convention[7] and thus recognise foreign trusts, there may be practical hurdles (local land laws or use ordinances) or efficiency considerations (particularly around tax) involving a transfer of property located in these countries into the hands of a foreign trustee. Different considerations apply in the US; for example, a foreign trustee may benefit from a structure in which a US LLC holds the property.

Solutions, in other words, rarely apply across all jurisdictions or the circumstances of ownership (e.g. the intention to rent out the house). If the trustee does not have the necessary knowledge of the real estate laws of multiple jurisdictions in-house, which is likely, it may be best served by hiring local counsel in each jurisdiction with the expertise to assess the most efficient ownership structure for each piece of real estate, while remaining mindful of the US aspects.

Insurance, local ordinances and regulations

Trustees must also manage real estate with an eye toward misfortune. It is obvious that a beach house on the Florida coastline is likely to see a hurricane, flooding and high winds, while a French chalet, depending upon its location, would be more exposed to damage caused by snow or ice. But beyond that, there are jurisdictional idiosyncrasies in the insurance market that only advice from local insurance brokers and lawyers can help identify. For instance, in the US, flood insurance may go through separate insurers as homeowners’ and renters’ insurance does not typically cover flood damage.

Additionally, it is worthwhile for the trustees to hire surveyors to ensure that the residence meets relevant local building codes, and to insure all valuables to avoid any problems with insurance coverage. It is also crucial to research the insurance company as there are big differences in coverage and responsiveness to claims. Trustees may find that insurance companies who cater to high-net-worth individuals and are owned by the policy holders are generally more responsive and willing to promptly pay claims than their larger corporate counterparts.

Conclusion

While the US Person beneficiary, and worldwide real estate, do give rise to complications, it is certainly workable for foreign fiduciaries to take on these structures and manage them efficiently. In an interconnected world with easy access to local experts and ‘tailor-made’ services and advice, trustees can ensure that they will be able to administer trust structures holding residential real estate for the benefit of US Persons to the highest standard.

Andréa Daley-Taylor and Catja Carrell, ‘The foreign fiduciary as global homeowner’, STEP Journal (Vol26 Iss10), pp.54-55

[1] For US federal income tax purposes, an individual is classified as a ‘US Person’ if he or she is a citizen or a resident of the US – here, a trustee should be aware of the green card test and the substantial presence test to avoid any surprises.

[2] note that for US federal income tax purposes, an individual is classified as a US Person if he or she is a citizen or a resident of the US – here, a trustee should be aware of the green card test and the substantial presence test to avoid any surprises

[3] See IRC § 643(i). This rule will also apply to the grantor of a foreign trust or someone ‘related’ to the beneficiary or grantor, as defined by § 643(i)(2)(B).

[4] https://www.irs.gov/forms-pubs/about-form-3520

[5] A Schedule K-1 form is prepared by the LLC to report the members’ share of income.

[6] https://www.irs.gov/forms-pubs/form-8938-statement-of-foreign-financial-assets

[7] Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition