In recent years, foreign capital played a large role in driving sales of New York City real estate. But in the last six months, some market analysts have pointed to local and national changes to suggest that such foreign investments may be drying up.
These analysts argued that the current real estate market is becoming less attractive to foreign buyers – the pace of sales in the Manhattan luxury housing market has slowed, forcing sellers to reduce their asking price to find buyers. Likewise, a glut of high-end rental properties has flooded the market, forcing landlords to give concessions to tenants.
At the national level, the resurgence of the U.S. dollar and the rise in interest rates have made the U.S. investments more expensive for foreigners. And the election of President Trump led to political and economic uncertainty, making some foreign buyers wary of investing in the U.S.
Focusing solely on these domestic conditions, however, ignored larger global changes that will continue driving foreign capital to the U.S. in the foreseeable future. In fact, because of these global trends, the U.S. has become the world’s preferred jurisdiction for offshore investments.
One major change pushing foreign money across the U.S. borders is the recently established system of international financial transparency, known as the Common Reporting Standard (CRS). More than 100 nations will begin automatically sharing details about each other’s residents’ offshore finances later in 2017 and 2018.
While the U.S. was largely the driving force behind the global financial transparency, the U.S. itself has not adopted the CRS, and is not likely to. This fact, coupled with the privacy protections offered by U.S. holding structures like trusts and limited liability companies, make the United States increasingly attractive to foreign capital.
These changes explain why, despite gloomy predictions, oversaturation of luxury market and the strength of the U.S. dollar, the foreign investments in the U.S. real estate soared to record levels this year at $153 billion as reported by the National Association of Realtors.
New Era of Global Financial Transparency
The Unites States have initially paved the way to financial transparency with the enactment of the Foreign Account Tax Compliance Act (FATCA) in 2010. FATCA requires that foreign financial institutions report to the IRS information about financial accounts held by U.S. taxpayers (or by foreign entities owned in substantial part by U.S. taxpayers).
In 2014, the Organization for Economic Cooperation and Development introduced the CRS, which was since adopted by over 100 nations. CRS requires signatories to collect information from their financial institutions and automatically exchange that information with other signatories.
The information shared under CRS includes identifying information about the owners of offshore accounts and certain financial information, such as account numbers, balance and any income earned on such accounts. If an account is owned by a corporation or trust over which a foreign individual exercises control, identifying information about both the entity and the individual will be shared.
Nearly 60 countries will begin sharing information in September of 2017. These include countries like the United Kingdom, France, Italy, Norway and Germany, and numerous jurisdictions traditionally favored for offshore investments:
- British Virgin Islands
- Cayman Islands
- Isle of Man
- Latvia, etc.
The remainder—including the Bahamas, Canada, China, Russia and Switzerland—will begin information exchange in 2018.
U.S. Role in Global Information Exchange
The United States has not adopted the CRS, and it is not likely to. Instead, the U.S. relies on FATCA and related intergovernmental agreements to collect information about its taxpayers.
Many of those agreements require reciprocity. That is, in exchange for other nations disclosing information about U.S. taxpayers to the United States, the United States has promised to disclose similar information about foreign taxpayers to their home countries.
On the surface, it may appear that the U.S. offers no more confidentiality than those nations that have signed the CRS. But this is not the case.
The U.S. obligations under FATCA only apply to accounts held by foreign individuals and foreign entities, and does not apply to domestic entities with foreign owners. In other words, the U.S. will not look through the domestic entity to collect information about foreign owners and beneficiaries.
FATCA is, in large part, a one-way street. The introduction of the CRS in 2014 only amplified asymmetry in global financial reporting, making the United States essentially the only jurisdiction offering privacy to foreign investors. This asymmetry in global disclosure regimes has already led to significant shifts in international offshore investing.
In 2016, Bloomberg reported that Rothschild had established a trust company in Reno, Nevada in 2014, just when the CRS was first introduced. Since then, Rothschild has been shifting foreign clients’ investments out of places such as the Cayman Islands and Switzerland to the United States.
Likewise, in 2014, Trident, a Swiss trust company, set up an office in Sioux Falls, South Dakota, moving dozens of accounts out of traditional offshore jurisdictions. By the time Trident began transferring those accounts, the amount of assets held in South Dakota trusts had already increased from $33 billion in 2006 to more than $226 billion.
The Allure of U.S. Holding Structures
One particular aspect of U.S. law has long attracted foreign investments: the privacy protections afforded by U.S. trusts and LLCs. These protections have become more significant in the age of international financial transparency brought on by the CRS.
Limited Liability Companies
Foreign individuals can form an LLC in any U.S. state. Although not every state offers the same level of confidentiality, some have become particularly attractive to privacy-conscious investors.
New York, for example, does not require the name or address of the LLC’s owners to be included in the articles of organization, which become a public record. Moreover, purchases of real estate can be closed by someone other the owner, such as a manager or an attorney. Thus, the identity of the foreign investor is often not disclosed at closing.
Likewise, U.S. trusts have long been favored by foreign investors as one of the vehicle to purchase and hold U.S. real estate.
By establishing a U.S. trust to hold real estate, a foreign buyer can effectively domesticate the trust’s funds while protecting privacy as the identities of the settlor and beneficiaries never become public. In addition to privacy, U.S. trusts provide tax benefits as federal transfer taxes do not apply to gifts from non-U.S. domiciliaries, and the trust can be funded free of U.S. gift tax.
Recent Enforcement Efforts
Recently, the U.S. government has taken some steps to make the purchases of real estate more transparent. In 2016, the Financial Crimes Enforcement Network (FinCEN) issued the Geographic Targeting Orders (GTOs) that require title insurance companies to report certain information about all-cash residential purchases involving a business entity, including the identities of beneficial owners.
New York City is one of the areas covered by a GTO. However, the scope of such GTO is limited – the reporting requirement only applies to purchases of $3 million or more in Manhattan, or $1.5 million or more in the other boroughs. In other words, smaller transactions do not impose a reporting requirement on title companies.
This fact may help explain why, although the Manhattan luxury market has slowed (with properties like those on Billionaires’ Row practically on life support), lower-priced home sales have not. Foreign investors are shifting their focus from one luxury home to more than one moderately-priced homes as investments.
In addition, GTOs do not apply to trusts – making all purchases made by trusts stay under the radar regardless of the purchase price.
More remarkable is that GTOs also do not apply unless a title insurance company is involved. Title insurance companies are not usually involved in purchases of new developments, since there is no title history to speak of. New developments have long been favored by foreign buyers, and the GTOs may only strengthen their appeal.
Because of these privacy protections and the absence of effective regulations, attorneys and advisors working with foreign client must remain vigilant to ensure that KYC requirements are met, and that foreign clients pass proper due diligence.
About Dilendorf Khurdayan PLLC. Our firm represents individuals, families and private funds across a wide range of U.S. real estate transactions including purchases, sales and leasing, construction, development, financing and joint ventures. We also work closely with non-U.S. residents looking to invest in the U.S., relocate their families to the U.S., expand business into the U.S. or pass wealth to the U.S. beneficiaries. We use our expertise in U.S. taxation, corporate law and cross-border transactions to structure inbound direct investments that are tax efficient and provide advice on FATCA, FIRPTA, CRS compliance, PFIC rules and CFC rules.
Max Dilendorf has more than 12 years of combined legal, finance and investment advisory experience in the commercial and residential real estate industry in New York and works with a diverse group of clients – owners, investors, developers, funds, tenants, landlords, lenders and property managers. A major aspect of Max’s practice involves advising foreign investors on effective real estate holding structures and tax consequences in connection with ownership, operation and transfers of U.S. real property interests.
Rika Khurdayan focuses on representing and advising foreign businesses and families in connection with holding structures, cross-border transactions, business operations and investment strategies. Major aspect of Rika’s practice involves counsel to high-net-worth individuals, families and investment funds in connection with optimal investment and holding structures for U.S. inbound transactions, tax-advantaged transfers of assets, pre-immigration tax strategies and acquisition, ownership and management of luxury assets, including real estate.