THE INTERNATIONAL TAX ADVISOR by: Douglas J. Kingston, CPA/MBA • Mailing Address: 16443 N 59^th Place; Scottsdale, AZ 85254 • Telephone: +1 (602) 595-5885 (GMT-7) • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/
NEW SWITZERLAND-U.S. INCOME TAX TREATY – ISSUES FOR SWISS INVESTORS IN U.S. REAL ESTATE
Background Rental Income and Expense Gain on Disposition Estate, Gift and Inheritance Taxes How Does the Tax Treaty Affect You? It is important for Swiss investors in the U.S. to review their estate plans in order to take advantage of the Switzerland-U.S. tax treaty.	Background After 17 years of negotiation, the U.S. and Switzerland have ratified a new income tax treaty effective this year. The new treaty provides several very favorable changes such as liberalization of the conditions for the reduced 5% withholding rate on dividends, reduction of the withholding tax rate on interest from 5% to zero, and implementation of the most flexible and favorable limitation-on-benefits clauses in Europe. On the negative side, the new treaty allows the U.S. to impose a 5% branch profits tax on Swiss corporations. In general, a tax treaty is a written agreement between two countries providing uniform bilateral tax rules intended to avoid double taxation of their crossborder citizens and/or residents. Tax treaty provisions override each signatory country’s own tax laws and may be invoked by the taxpayer if the treaty rule provides a lesser tax than domestic law of the taxing country. This article focuses on some of the more common U.S. and Swiss tax issues encountered by Swiss resident individual investors in U.S. real estate (not U.S. citizens or “greencard” holders). Rental Income and Expense The new treaty does not override U.S. tax rules for income derived from the use of U.S. real property. Under U.S. domestic tax law, rental income derived from U.S. real property is subject to a 30% withholding tax imposed on gross rents unreduced by expenses or losses. However, U.S. law provides foreign investors the option of timely filing U.S. tax returns and electing “net basis” taxation at regular tax rates up to 39.6% and alternative minimum tax (AMT) rates up to 28%. Once the election is made, it can only be revoked for subsequent years with IRS consent, and the election applies to all of the investor’s U.S. real property rentals. In addition to “ordinary and necessary” expenses (such as mortgage interest, property tax, insurance, repairs and management fees), allowable tax deductions include straight-line depreciation computed over 27.5 years for residential property and 39 years for commercial property. The new treaty provides that making the election is subject to the procedures of U.S. domestic tax law. Under Swiss domestic tax law, generally, a Swiss resident’s overseas net rental income is subject to Federal tax at rates up to 11.5% and Cantonal tax at rates from 14% to 35% (with credit for foreign country income taxes paid). However, the Switzerland-U.S. income tax treaty overrides Swiss domestic law with the result that U.S. real estate rental income is exempt from	Rental Income and Expense (continued) Swiss income tax. Though not taxable, the exempt income is taken into account in determining the tax rate on other Swiss-taxable income (this is known as the exemption-with-progression rule). Gain on Disposition The Switzerland-U.S. income tax treaty does not override U.S. tax rules for gains derived from disposition of U.S. real estate. Thus, a Swiss investor’s net U.S. real estate gain is generally subject to graduated rate taxation under the regular tax or AMT rules. For dispositions after May 7, 1997 U.S. gains taxation is generally limited to a maximum rate of 28% for property held more than 12 months and 20% for property held more than 18 months (in either case, gain attributable to prior depreciation is taxed at a maximum rate of 25%). Under Swiss domestic tax law, a Swiss resident’s overseas real estate gain is subject to Cantonal, but not Federal, capital gains tax. However, the Switzerland-U.S. income tax treaty overrides domestic tax laws with the result that U.S. real estate gain is exempt from all Swiss income taxes under the exemption with progression rule. Estate, Gift and Inheritance Taxes The existing Switzerland-U.S. estate tax treaty ratified in 1952 remains in effect. Under U.S. domestic tax law, the value of U.S. assets of a nonresident decedent who is not U.S. citizen is subject to tax at graduated rates up to 55% after exemption of only $US60,000 (not the $US600,000 increasing to $US1 million by the year 2006 available to U.S. citizens and residents). However, under the Switzerland-U.S. estate tax treaty, the larger exemption is available to Swiss resident decedents “prorated” on the basis of U.S. assets divided by worldwide assets. The Switzerland-U.S. estate tax treaty does not provide the unlimited marital deduction available for transfers to a surviving U.S. citizen spouse. Under domestic tax law, most Swiss Cantons (but not the Federal government) impose inheritance and gift taxes on the value of worldwide assets except real estate located abroad. How Does the Tax Treaty Affect You? This article considers U.S. Federal, but not U.S. state and local, income and transfer taxes. Swiss investors in U.S. real estate should be aware of the benefits available under the Switzerland-U.S. income and estate tax treaties, and plan their investments accordingly in order to reap the maximum tax savings.
Douglas J. Kingston is an Arizona certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be reached by: • Telephone: (602) 595-5885 • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/