Anyone buying an investment property in United Statesshould be aware of important basic tax issues affecting foreign investors owning residential investment property there.

Each state in the US has its own separate tax regime, consequently any potential investor must seek tax advice specific to the state in which the property is located.

For the purpose of this article, let's take a residential condominium unit located in the city of New York, state of New York, rented on the open market and considered for US tax purposes as residential rental property.

Determining the most effective ownership structure for an investment will depend on each individual investor's circumstances. Consequently, deciding whether to buy in your own name or using a corporate structure is not a straightforward decision. Failing to take tax and legal advice to properly structure the ownership of your investment is reckless and the consequences can be extremely expensive.

Let's take it that you purchase the property in your own name or in the name of a single member limited liability company (LLC). Single member LLCs for US tax purposes are considered as "pass through entities" (an entity not recognised for US tax purposes) and are taxed at the individual taxpayer level of taxation. Consequently, from an income tax perspective, a foreign investor must file (1) a US non-resident alien income tax return form 1040NR and (2) a New York state non-resident income tax return form IT-203 each year to report the annual results of the operation of the rental property.

Generally, there are US tax consequences if there is a sale of the property or the beneficial owner dies. If there is a sale of the property, the beneficial owner will receive preferential capital gains income tax treatment, if the property is held for a period of one year or more. The profit from the sale will be subject to federal income tax at a special capital gains rate of 15 per cent and New York state income taxes at a rate of approximately 6.85 per cent (the city of New York does not tax non-residents of New York city on the capital gains income).

This assumes that the foreign investor is not being taxed on the AMT (alternative minimum tax method) for US tax purposes. If the foreign person is taxed on the AMT, the total combined tax rates may increase up to approximately 34 per cent for US and NY state tax purposes, depending on the taxpayer's specific tax situation in the year of sale.

Foreign investors are subject to a federal withholding tax (FIRPTA), at a rate of 10 per cent of the gross selling price at the time of sale and a New York state withholding tax of 6.85 per cent on the net capital gains profit on the sale of the property. The FIRPTA and New York state withholding taxes are in effect a prepayment of the foreign investor's US and New York state tax liability on the sale.

However, if the foreign investor should die while still owning the real property, the property will be subject to probate in the US. In order to transfer the ownership of the property to the beneficiaries, it will be subject to US inheritance tax (estate tax) at the fair market value (FMV) of the property at the time of death, less any mortgages on the property.

The rate of such tax for a foreign investor is approximately 45 per cent for the year 2007 (note that this estate tax rate will increase substantially effective from 1/1/2011 up to 55 per cent) and up to 10 per cent estate tax for New York state.

This, by any measure, is a huge tax burden and in certain circumstances can have a devastating effect on what was considered a valuable asset. There are ways to mitigate this liability, i.e. to purchase term life insurance equal to the amount of the estimated estate taxes so that the beneficiaries can pay the inheritance tax without having to liquidate the property (the FMV of the property needs to be monitored constantly and the term life insurance increased as required).

If properly structured the proceeds from the insurance policy itself will not be subject to US estate tax. Please note that the individual and LLC types of ownership structures are least confidential. The foreign person would be required to apply for an ITIN (Individual Taxpayer Identification Number) with the US Internal Revenue Service.

Whilst there are various other ways of structuring your investment, each will have its own advantages and disadvantages. In short, it is important that you take good advice before you buy and even after you have bought, so that you become an informed investor and make and hold your investment wisely.

Denis Jacobson is a solicitor with Crowley Millar solicitors in Dublin