A recent case has given me information about foreigners (non- citizen non-residents) owning real estate in the United States, that I was unaware of. Other tax professionals I have talked to were unaware of the full picture, so I thought I'd mention it here.
Most people are aware that an inheritance given to a spouse does not qualify for the unlimited marital deduction if the spouse is a non-citizen, non-resident, unless the gift is made in a domestic marital trust that will assure the surviving spouse's estate will pay estate tax on that property on the second death.
But I was unaware that domestic trusts are available to couples when neither of them is a citizen or resident. In that case the unlimited marital deduction can apply. Otherwise there is a very small marital deduction (as I recall just $14,000).
However the domestic marital trust is really not a good estate planning tool. Why? Because when a non-citizen non-resident dies owning property in the US, the lifetime exclusion is miniscule (maximum of $40,000, as I recall).
Not only that, but mortgages are not allowed as a straight deduction on the 706. Instead the estate is required to list all worldwide assets, and a mortgage is only deductible in proportion to worldwide assets. So if someone owns a property worth $500,000 but has a $400,000 mortgage, but they own a total of $2 million in property worldwide, only $100,000 of the mortgage is deductible. So the estate tax on that US property might be higher than the equity on the property.
And if the estate either elects not to declare worldwide assets (or the IRS doesn't believe that all such assets are disclosed), they will not allow any deduction at all for real property mortgages. So in the example above the tax would be at least double the equity in the property.
I can only think of two ways to avoid this property. The first one is never die. But that's unrealistic.
The other option is to have US real property owned by a foreign corporation rather than a foreign citizen/resident. In that way the stock is considered foreign based property, and the property itself is not counted in the estate.
Any thoughts?