[ HTJ Podcast ] US Property Investing -Investment Structures- with Jay Knight & Derren Joseph

 

 

HANNA MUSIDI:

Hi, my name is Hanna, and today we have our US tax expert, Derren and we also have our US real estate and legal expert, Jay, and we will be discussing investment structure.

VOICE-OVER:

This podcast channel it's about you, successful international entrepreneurs, successful ex-pats, successful investors. Sponsored by HTJ.tax

DERREN JOSEPH:

Jay, how are you?

JAY KNIGHT:

Great. How are you doing?

DERREN JOSEPH:

 Pretty good. Good to talk with you again and continue this great series that we're doing. So I let you start first, please introduce yourself.

JAY KNIGHT:

Sure. My name is Jay Knight. I am an American citizen and am living and working in Indonesia. I'm a licensed real estate broker in California, and I still have business operations going on out there, but also doing real estate out here as well. So that's a little bit about my background.

DERREN JOSEPH:

Okay. My name is Darren Joseph. I'm an international tax consultant and my specialty, my team's specialty is US international tax. And today we're going to get into the third installment in our series on investing in US real estate, Asian investors. And of course, as we said previously, so we have to give you use your disclaimer. We are not giving tax advice, maybe a tax advisor, but I'm not your tax advisor. Jay may be a real estate broker legal advisor, but he's not yours. So we just have a general conversation around general principles that would guide your conversation with whoever you retained to advise you on your real estate journey. So with that in mind, I think Jay has some questions for me.

 

JAY KNIGHT:

Absolutely. Yeah. You know, so let's just dive right into it. So we've talked already in the past a little bit about real estate and what the transactions are and how the buildup for it is and all the things that we need to do. So let's talk a little bit about how we hold property if we're going to buy from overseas. So should an overseas or an agent investor hold property in their personal name, or should they hold the property? What would be the most, the biggest potential?

 

DERREN JOSEPH:

I think the biggest potential risk is that if the vendor, some sort of legal dispute in the US someone can come after you personally, and that's your complete, you know, complete network. So that will be not just that particular real estate investment, but potentially all your real estate investments in the US or even your, your assets back in Indonesia, Malaysia, Singapore. So, I mean, if they want it to go the way that could, because it's in your name and you are personally liable, should anything happen in addition to which there is also the idea of US taxes. So typically it presents no advantage to hold it in an entity from an income tax perspective, but potentially from a transfer tax perspective. I mean, are we talking about specifically US estate taxes? Unfortunately, at some point in time, we're all going to pass away. And if it is a US real estate investment in your name, it could present US estate tax liability. When it goes, when it goes through the probate process and is passed on to beneficiary wife, husband, kids, siblings, or whatever your wishes are, they could be alive, which could be mitigated if you were to hold it through a structure.

 

JAY KNIGHT:

 Yeah. So, I mean, let's say you had a net worth of $10 million and you hold a property in your own name and you get sued, you put your whole net worth at risk. Right. So it's a huge liability. Yeah, absolutely. All right.

DERREN JOSEPH:

Yeah, absolutely.

 

JAY KNIGHT:

We don't want to do that. So what about holding the property in some sort of an Asian entity? So you have an entity in Indonesia. Would that be a good idea?

 

DERREN JOSEPH:

You could, and people do, you know, we have Indonesian investors who decided to hold it in the name of the  PTU through an entity in Singapore or whatever. But I see a number of downsides to that. One of which is taxes, because it's a foreign entity, you know, that there are certain additional tax burdens, which may result. And this is something called the branch profits stats, which I probably won't get into right now. But what else summarize it to say is that you pay more taxes than you could with alternative structures. You may, and then the second thing is around privacy, just like holding it in your own name. The idea is just to keep your personal affairs crystal, and you may not, once they the tenant or anyone in the US to know that the ultimate winner is a family in Indonesia and Singapore, you don't want any, once you get ideas, you just, maybe it will be a company, the company that you use, maybe well-known, and you don't want people to know who you are. So there's, I mean, there's nothing wrong with being private. In fact, under certain circumstances, it can be a good thing. So in short, I think for certain potential tax reasons, as well as just privacy, I would advise typically, I mean, some cases, it may make sense depending on what your overall portfolio, what your overall objectives are, but generally speaking, holding it in a foreign entity, particularly an Asian one, not always a good idea.

 

JAY KNIGHT

Okay. Fair enough. What about different types of entities in the United States? Like an LLC? Maybe we can, you can talk a little bit and explain a little bit what an LLC is and what would be the benefits, of holding something.

 

DERREN JOSEPH:

Yeah. So the LLC is a strange creature and law, which is tricky to explain to those when, not from the US because there's no direct equivalent in Indonesia, Singapore, Malaysia, but suffice it to say that in the US it is a Republic. And so you have the federal law, and then you have state law, which I guess is to be fair, is not so different, like from say Malaysia, which is also a Federation, so that there are some similarities there. So under US law, the states have the ability to recognize and incorporate entities. But when you do that, the federal government does not know how to interpret it. So if it is that you form an LLC and you're one person, or maybe your family, so husband and wife, then it's an LLC. So it's a limited liability company at the state level. So it's like a PT in Malaysia or private limited in Singapore, Cindy Ranbir had in Malaysia and the state level, but at the federal level, it's less clear. So if it's a husband and wife, this, the federal government will each understand, okay, do you want this to be treated like a partnership because it two of you, or do you want it to be treated like a limited liability company, a company limited in its liability. So do you want it to be a pass-through, or do you want it to be a separate legal person in front of government based on the standard? Similarly, if you're just like one person or one person investor and you form the LLC at the state level, yes. It's a limited liability company, but at the federal level, the federal government wants to know, okay, is this a pass-through you, are you trying to do this as a sole proprietor? Or do you want to be a company? So you need to make that distinction. And in addition to Richard, remember, we're saying that you need to form it first at the state level, there's this hybrid thing. So you need to turn it down with the state. Everyone says, ooh, US LLC, Delaware, Delaware, Delaware, Delaware. And the reason why, you know, Delaware has stood the test of time. It has a great statute on those boats, which were in favor of investors or employers or business owners, as opposed to some states which needs sometimes to lean towards creditors or potential employees and stuff like that. So it offers great protection on the side of the investor. So we get Delaware, but you lose that protection. If you were to form a Delaware, LLC, and then try to buy an operation, you buy an operating real estate in California and New York. Then, in fact, you neutralize or nature. You Delaware, the strength of the Delaware, LLC. And you now have a California LLC. So the two things, the point is that this is not a simple process that you should definitely, definitely, definitely take legal advice because of the whole thing of state versus federal, and depending on what you are and what your investment strategy is and what the nature of your portfolio is. One structure may be more efficient than others, and then different states have different rules. And depending on where your real estate is located, you would need to have an LLC in that or an entity in that state to do business with permission to do business. But you should also be looking at an umbrella structure that offers the, even though it may be a California property, you can still have something, or you may have a California LLC, but that is protected above it by the Delaware, LLC. So those kinds of structures offer maximum tax efficiency, maximum anonymity, and protection against potential liabilities.

 

JAY KNIGHT:

All right. That's a great answer. Now, one thing maybe you just can go a little bit further into, so people are listening are clear, is you mentioned about a pass-through. Maybe you could explain what that means. So for people that are not familiar with that term, what does that actually mean?

 

DERREN JOSEPH:

Yeah. And this kind of, and that you have formed a limited liability company at the state level, but you need to explain to the federal government, by filling out a form that basically an entity classification form, how do you want this LLC, which you folded the state to be treated by the federal government. And if you don't see anything, the default is a pass-through. So the equivalent in, you know, like Malaysia, Singapore, and Indonesia would be if it's one person, a sole proprietor. So you just have a business in your own name. So even though it's an LLC, so you don't say anything because it's just you, the federal government says, well, he hasn't said anything. So maybe he's just in his own name and that's it. So it's about a certain, say it passes through to you personally, which is more, more, more the previous question it passes through to you with all new strengths and weaknesses that, that entails. And if it's to a more view, then when we said pass-through, then it's a partnership. So, and again, we have partnerships in Indonesia and in Southeast Asia. So we know what a partnership is. And again, at the federal level, you've taught by not saying anything or electing in that favor, you've told the federal government, you know, what, I'm ultimately responsible. So I don't want any protection in between myself and my investment. It's just me, which sometimes can make sense. Sometimes it's part of a structure that does make sense but on its own.

 

JAY KNIGHT:

All right, great. That makes a lot of sense. And hopefully, that will clear that up for anybody who was not familiar with what passed through mean. So, let's take it a little step further. So if, if you want, if you were looking to invest and you think LLC is the way to go, is there a, a cheap way to, you could set up an LLC and you know, America and, you know, for under a hundred dollars, or how does that normally?

 

DERREN JOSEPH:

Absolutely. And that's the thing, you know, that so much inflammation or the internet, you know, and that's why we say don't take tax advice, tax advice from us. What we try to do. If you have questions that you can ask the advisor that you eventually engage, engage someone who understands your situation, you kind of look at them again on YouTube podcasts. You kind of read an article or look at some group on LinkedIn or Facebook, especially. And because this one guy or lady and worked for him or she assume that it works for you. And that's the people that the businesses out there they're like LLC mills. And it's just thousands of LLCs a week. If not per day, I don't know. And the premise of one size fits all, which we've just established this sibling does not. So a lot of the problems that a lot of the businesses would do in this space is cleaning up past mistakes. So someone thought I've done a pizza in the gym, my own, I've done my simple, private limited. It's so easy. And I'm a brand ambassador in Malaysia, I don't need any help. I know how this stuff works.  I'm a successful entrepreneurial business owner. I don't need to pay for this. I can save some money, but it tends to bite you and you need to do it later on when you create all these unintended consequences of gray and cheap. So the backside is up to you.

 

JAY KNIGHT:

Very true. Very true. All right. So what about, let's talk a little bit about the tax. This is really your specialty. So maybe you can give us some enlightenment regarding the tax system is.

 

DERREN JOSEPH:

As everyone knows, right? Because you know, once you have any taxes in the media, you see movies, you know, that the tax system is unusually complex and some argue that it's the most complex in the world. Some people say Brazil, but some people say the US, but it does take some getting used to, and it is unusually difficult to navigate. So I've never seen someone from the outside who maybe has if you've gone to like the university of US and maybe you work with a multinational medium, you kind of familiar with it. But if you're just walking in, I have not seen anyone really figure it out. So just, and so it's, it's huge. I mean, at the federal level, it's like equally in words, as a tax school and growing, and then you have 50 states, and each tax court within states is in the millions of words as well. So we're not going to explain this in five minutes, but just, just summarizing just one really high level. You have probably four levels of taxes. You have the federal tax, which is from Washington DC for that's like at the national level and federal level, as we say, and then states have taxing rates as well. So if you're in California or in New York, then the state of New York will chat to you and whatever rental income you may have, or when you sell and you sell it for more than you paid for it, that difference you pay taxes on that as well. And then at the city level, you may have to ask as well. So for the city of New York using the New York example, so that's the third level. So you have federal states of New York city of New York is that three levels so far. And then you may have county-level taxes. So let's say you in a particular locality, then locality may have the ability to levy taxes. And that may just be a property tax, which is a levy, not on the income you earn from the property, but just the value of it is a reasonable value and whatever. And there's a calculation based on that. And that may be the flood level of tax. So that has obviously has implications, right? Because when you go in and you're a smart investor, you'd need money in your home country, in Asia. So you know how to assess risks and opportunities. And you may have like a spreadsheet to figure out a rental unit, especially one of those, if you want of those that have done one of the many courses or whatever, let me get a sense for all you can Google. You can see how much it costs you can. When you're putting in all Casio, we need to worry about interest. Once it's structured in such a way that you lend yourself the money, which is a different conversation, but you know what the expected rental will be and anything, Hey, you know what? I can make money on this. Not remembering that taxes are due and tax. And is the scale from something that is attractive investments, something that is not. So that's what people also forget about, depending on how your pool. It may be subject to escape taxes, which is where it is like death tax. So if you move it in your own name, or if you hold it under certain structures, when you pass away, unfortunately before it goes to your, the next step, like you, your spouse or your kids, or whatever attacks on that estate. And we do at the federal level, depending on how much it is. And it may do the state level as well. So maybe hit twice and those are pretty high. So that's definitely something you want to consider, especially if you have a long term, like a buy an old strategy, and you tend to just look at it as a rental yield, as opposed to flipping it.

 

JAY KNIGHT:

Sounds pretty expensive to die

 

DERREN JOSEPH:

But if you prepare it's manageable.

 

JAY KNIGHT:

Oh, that's good to know. You said, there are federal taxes and state taxes. And I'm like, hey goodness. All right. So, you know, we've talked about LLC, right? We've talked about a state tax and different taxes. Maybe we can talk a little bit and you can explain a little bit the difference between an S Corp and a C Corp and how those in taxes are kind of interrelated.

 

DERREN JOSEPH:

All right. So this is an academic discussion because one of the limitations of an escort is that its foreigners aren't allowed to non us persons can't be an owner or shareholder, depending on how you look at it in an asshole, but essentially the S-corp is like an entity that's kind of in-between an LLC and a secret. So it's like the in-between guy. So, you know, depending on who you are, and depending on your, your tax-wise, there may be some higher tax liabilities when you use an LLC, which could be mitigated if you were using an escrow. So it'll go down a bit, but of course, this is not relevant to a foreign investor audience, but if you're a US person, that's definitely something to consider. So the conversation is about an LLC versus a C Corp. So a C Corp would be a regular company, like for example, like Facebook or zoom, or whether it be publicly listed or privately held, it basically is telling the federal government that a higher level of protection between myself and this entity, that this entity is definitely a separate person from myself. And so that wall, because we talked, we spoke about protection and the need for protection, just generally speaking gives you a high level of protection, but they're also different tax consequences to consider. So essentially, depending on how you structure it, you may pay tax twice on the same income, at least at the federal level. Are we talking about this is because the entity, because it's a separate legal person in law, the federal level prepares its own tax returns and pays its own taxes, which is something you're familiar with because that's what a private limited does in Singapore. That's what a PTMA does in Indonesia and so on. So that's normal, but whereas like say in Malaysia and Singapore, the dividends may not be taxable. The dividends would be taxable in the US so in other words, that seed money maybe chats twice once by the company pays taxes and then to receive it as dividends, you pay taxes as well, but depending on what your, your strategy or structure is, especially if you want to venture into commercial real estate, as opposed to residential, and it's something that's worth considering and worth understanding in greater detail to see if it's relevant to you. It may be.

 

JAY KNIGHT:

Yeah. All right. And for those of you that don't know the difference between commercial real estate and residential is, is simply that if you buy a building that has over four units or four units or more, and it's considered to be a commercial ability as opposed to a residential one. So it will also have different tax liabilities and different kinds of things like that and also differ in terms of how you purchase it in where you look for and all that stuff. But we'll talk about commercial real estate at another time. So great. All right. So let's keep moving. What about, maybe you can explain to everybody a little bit about what trust is and a foundation and how they may differ and how they kind of fit into the big scheme of things.

 

DERREN JOSEPH:

Sure. So from well-known Indonesian-based investors, because it tends to be, it's a creature that's quite popular in civil law jurisdictions like Indonesia, whereas a trust is more popular, common law jurisdictions and sassy, not recognized in civil law jurisdictions anyway. So in Malaysia with trust law, but essentially different, I would say entities just for the sake of being simple. But for those of you with a legal background, you're going to say, oh, this is not an entity. I know that just for the sake of keeping it simple, it's a novel way of holding your real or structuring your real estate investment and not necessarily offer tax efficiency. Nailed me. Not just, not necessarily a tax play, but it's often around anonymity or privacy, as well as to some extent asset protection and probate avoidance. So because in, in most legal systems, as everyone knows, when someone passes, there's a process for transferring assets from whoever the beneficiaries may be. So that helps. And that these structures may help in that process. There may be some tax benefits, but there was what I want to say is that somehow equated trust and foundations with tax dodging. So this is tax avoidance and tax lesion. And that's not the case. It's not a tool that you should think of as synonymous. Well, that's how you get to be in the taxes because I watched a movie and the trust, the foundation, and no one paid any tax. That's not the intent, but definitely does not necessarily the intent walking in. So in short, it's another structure or a relationship. If you're talking about a trust that allows you to hold your US real estate investment, that it should be considered because it may or may not be relevant to you. So when you consult with your advisors who would know your situation, that perhaps would be one of them, the tools that they may leverage to make sure that you're well protected.

 

JAY KNIGHT:

Yeah, absolutely. And, you know, just, just to piggyback off that the whole idea of the trust really is to create a, as you said, it should be part of your overall estate planning, kind of a strategy. It's not necessary to avoid taxes, although that could be, you know, an ancillary benefit of it, really it's to be able to transfer property that you have to someone else at a later time. So basically the trust will set up these, that set up is basically a set up for a beneficiary that you deem, and there's a trustee. Who's gonna run the trust for the benefit of the beneficiary and have some sort of fiduciary duty to, to run it in their best interest. So I'll look at and talk in more in-depth also about trust. What about foundation foundations? I know you touched on it briefly, but maybe tell us a little bit about what exactly it does and why people may want to set up a foundation, something that's interesting to them.

 

DERREN JOSEPH:

Well, that one definitely offers under certain circumstances. Once it's deployed in the right way, it does offer some sort of tax benefit. And it allows you as opposed to when you're using a trust, the different types of trusts, obviously. And if you're using a, what we call a non-grantor irrevocable trust, basically as the original investor may lose control. And that's a positive process, you, you turning it over to the trustee as, as you mentioned, Jay, whereas a foundation allows you to remain in control since a separate entity, but together with like a management committee of sorts, you can be involved in managing and guiding the process. So that's one of the key benefits, but it comes at a price in that it's heavily regulated. So in order to have that benefit of being recognized as a foundation, there are the compliance burden is pretty high. So you have to follow a lot of rules and there's a lot of oversight by whichever jurisdiction you choose to form your foundation. If it's in the US, it might be, let's say a 501C3, if that makes sense for you as part of your strategy, maybe it does, maybe it doesn't. But if that's less just using the US as an example, to get that recognition by the internal revenue service that you do have a foundation, a 501C3, which is a charitable foundation that's. So that's a code section we use, which are with charitable foundation. You know, back in the day, do use to be like three, four months to get that approval letter. But now it takes about a year or more. It's not unheard of more than a year. And, you know, the IRS keeps an eye on it. And if you violate any of the smaller terms and conditions, your status could be revoked. So again, it makes sense for you given your situation. And of course, once you take legal and tax advice that could be worked out, whether it works for you or not.

 

JAY KNIGHT:

You know, one other thing I was gonna have you touched on as well is when you talked a little bit about the taxes that you're going to potentially have to pay. And you talk about that because where we, if you buy a property in the US those taxes that you are referring to are taxes that are being paid in the US what about if you're an Indonesian and you say you're Malaysian and Indonesian, Singaporean, Filipino, you know, anywhere in Asia and you buy something in the United States. Yes, you pay taxes on the property there through whatever entity you're structured that you have set up. Or what about paying taxes, where you are in your home country? Do you also have to pay taxes there as well on the property or on the entity?

 

DERREN JOSEPH:

That's a great question. And that's why we also advise that to have both tax and legal advice, not just from the US perspective, but also from your local perspective. And somehow they need to speak to each other, which becomes difficult if you're using someone who's based in the US whereas if you have a team like ours, we're not the only ones who understand bullet Indonesia, us all to the same office, or Singapore, US-Malaysia, US, Philippines, US-Vietnam, US-Thailand, US whatever. Then you have a joined-up view and you write and see what jurisdiction is. For example, Indonesia, very aggressive. If it is that you have a real estate portfolio overseas. Yes, absolutely. No doubt. That is taxable in Indonesia. No doubt because you to the conversation, right, if you're in Singapore, Malaysia becomes a bit of a gray issue, because if it is, you are managing a real estate portfolio from Malaysia, Singapore, even though Malaysia and Singapore say, well, we only check you in a territorial on local source income. Only the point is that you're running a real estate business, or you're making decisions from Singapore, Malaysia. So technically it should be taxable and Singapore and Malaysia, but again, with good advice, you can set up a structure that is compliant with the tax rules and Singapore, Malaysia, where you may not have to pay taxes on the money that's new overseas. And that to sound like a stuck record, but that's why it's really, really, really important that on the front sight that you get before you enter into this, to make sure that you set it up in the right way, and you don't have any uncomfortable encounters with local tax authorities.

 

JAY KNIGHT:

Absolutely. Yeah. I mean, you know, you covered a, a large array of, you know, taxes and entities. And I think, you know, it's been really useful and beneficial for people to kind of hear and understand this, but as you mentioned, yes, it is extremely, extremely important that you talk with a professional, especially, you know, someone that can understand and knows your situation upside down and backward and everything, to make sure that they give you the best advice. But yeah, it is complicated. And there are a lot of different factors and a lot of different things that you have to take into consideration. But, and as you said before, there's no one size that fits all. So you have to really have someone that's informative about the different types of entities, the different types of laws, and so forth and so on. So, but this has really been enlightening and I'm really glad that we had opportunities to kind of discuss this in greater depth. And I'm hoping that we can continue the conversation and continue to learn and continue to educate others about real estate investing information to the US let's keep it up. I'm looking forward to the next one.

 

DERREN JOSEPH:

Awesome. Likewise.

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