US Capital Gains Tax for Foreign Investors

Editorial team of TFX

• 22.09.21 • 5 min read

Technological breakthroughs have made it possible for investors like you to invest their money around the globe. While doing so you need to get familiar with the tax laws of the country you are planning to invest in. In this article, you will find out how US capital gains tax for foreign investors works.

What is capital gains tax (US)?

The Internal Revenue Service (IRS) collects capital gains tax on capital assets. 

Let’s say you sold your capital asset which can either be real estate, stocks, jewelry, or bonds. If the proceeds you received are higher than the amount you paid for it, you had a capital gain. And you are liable to pay capital gains tax to the IRS depending on how long you have held those assets. 

Capital assets can be split into two forms 

• Long-term capital assets: These are held for more than a year. Capital gains tax rates are applicable on these gains.
• Short-term capital assets: These are held for less than a year. They are taxed at an ordinary income tax rate.

Since for most of the taxpayers, the income tax rate is higher than the capital gain tax, therefore, they hold the capital asset for at least a year to avail themselves of the tax benefits. The IRS also allows capital gains to be offset by capital losses so few investors make the most if by selling their low-performing investment at a loss.

What do taxes for foreign investors depend on?

How foreign investors are taxed depends upon their residential status and type of investments.

Residential Status

For tax purposes, you can either be a resident alien or a non-resident alien.

Resident Alien

A resident alien is a person who was born outside the US and migrated from a foreign country. To be considered a resident alien you need to meet one of the two conditions.

Hold a green card.

OR

Pass a substantial presence test that determines your physical presence in the United States. If you were physically present in the country for 31 days during the current year and 183 days in the past three years you will be considered a resident alien for tax purposes.

Non-Resident Alien

You will be classified as a non-resident alien if

• You are an exempt individual. A student, teacher, or a person seeking medical treatment are a few examples of exempt individuals.
• You do not hold a green card.
• You haven’t passed the substantial presence test.

As a non-resident alien foreign investor, you need to file a W-8 form with the IRS to continue to verify your country of residence for tax purposes. The tax authority will ensure your residential status and will allow you to reap the tax benefit. 

Types of investment and earnings generated from it

Real Estate

Foreign investment in real estate can result in two types of income

• Rental Income: This is the monthly income you receive from your tenants. You will keep on generating this every month as long as your tenants stay at your property.
• Capital appreciation: This is a one-time gain that you realize when you sell the property after its market value increases. 

US Stocks and bonds

• Dividends and Interest income: Depending on whether you are investing as an investor or creditor you will earn dividends or interest by investing in US stocks and bonds.
• Capital gains from trading stocks and bonds: Upon selling the stock in the market you might earn capital gains.
• How are resident aliens taxed in the United States?

As a general rule, a resident alien is treated the same as a US citizen for tax purposes. 

The long-term capital gains will be taxed at a rate that will be determined by looking at your tax bracket. The short term-term capital gains will be taxed at your ordinary income tax rate. 

It is noteworthy that if you have realized capital losses you can deduct them from your capital gains. The net capital gains will then be taxable.

How are non-resident aliens taxed in the United States?

Capital Gain, Dividends, and Interest Income

The capital gains tax changes for foreign investors with non-resident alien status.

Generally, if you are not effectively connected with a U.S. business, you do not have to file a US tax return. This is true for the capital gains earned. But you might have to pay taxes on your capital gains in your home country.

The rate of taxation of foreign investors in US companies is 30%. Any dividends and Interest income earned by a foreign investor through a US company are taxable at this rate. 

Dividends received from a foreign company are not taxable in the US. The distributions and capital gains earned from short-term capital assets will likely not result in US tax liability. But you may need to report your income in your home country.

You can hire a brokerage firm, who will compute taxes on your US gross income and withhold it. They will then pay and report this withholding tax directly to the IRS.

Short-term capital gains and distribution earned from it will likely not result in US tax liability. But you may need to report your income in your home country.

Estate tax or transfer tax & Gift tax

Consider a foreign investor with a non-resident alien status dies leaving situated property either tangible or intangible behind. And the value of these assets together with the gift tax specific exemption and the amount of the adjusted taxable gifts is higher than the threshold of $60,000. In this situation, the executor is required to file a Form 706-NA for computing and reporting estate tax. 

Tax treaties

If there exists a tax treaty between the US and your home country your tax liability will be lowered. A tax treaty prevents your income from being taxed twice. 

This means if there is no tax treaty then your income will be taxed in your home country as well as in the country you have invested your money in.

Taxes for foreign investors, who are non-alien residents, may get a little tricky.  Getting the advice of a business tax accountant or other professional tax expert is always a good idea.