Americans Are Buying Dubai Real Estate, But Most Don't Know This Tax Rule

How can Americans reduce their taxes when they're investing in Dubai in the UAE? Can they? We're going to find out Welcome back to the The Dubai Connect podcast hosted by myself, GG Benitez, a certified international property specialist and a licensed realtor in California and here in Dubai helping guide global real estate investors into Dubai and the UAE. And this is a question I am asked on a daily basis and I finally have the answer directly from the expert. Hello Amir from Finnection, is that what it is, right? Is it How do you spell that? F i n n e c t i o n. It's combination of finance and connection. I love it and I just met you Amir. We You reached out to me a couple days ago. I'm actually flying back to the States tomorrow to host, by the way, with an international tax attorney in the United States an event to help educate Americans because it's very hard to find someone who understands cross-border tax accounting, but here you are. Thank you. Can you share a little bit about your background and your expertise? Sure. So, I am an enrolled agent in US and it's a designation granted by IRS and that allows me unlimited right of practice in front of IRS similar to CPA or tax attorney in terms of representation to IRS. And yeah, we So, my accounting practice is in Canada, US and UAE and by virtue of doing taxes in these three countries besides bookkeeping and accounting, we are that has kind of become our niche to, you know, do cross-border because there are tax laws for Canada, there are tax laws for US for UAE, but there is no tax book for, you know, cross-border. You always have to consider one law, second law, the treaty between the two. Well, there's no treaty between US and UAE. So, but generally that's what you have to consider to arrive at a solution. So, it's very exciting and it's very interesting because every time there's a different situation. I'm glad you find it exciting cuz I find it scary for me to Well, first of all, it's not my position to advise, right? My job as the The Dubai Connect is to really to find the experts who are licensed in their field to understand and have the experience to properly help my clients strategize. So, one question I am asked regularly. Mhm. Most of my investors are from the United States, some are from Canada, some are from the UK. But for an American investor purchasing property in Dubai, is there a way for them to minimize their taxes? Yes and no. Okay. Okay, it's a yes because you can do something about your taxes when you have a property here and we will go specifically into different income types. Okay. And no because generally when this question is asked, the person really wants to know, do I really have to declare it? So, the answer is no, you have to declare it. In fact, the United States is one of two countries in the world where you have to declare your worldwide income. Yes. I don't know how many there are though. I know for a fact US and Canada, yeah. So, you can say there are two countries where you declare your worldwide income, that's true. Okay. So, now my next question is this. They purchased property here. They own an off-plan project. Okay. Is that technical That's not income yet. So, do they have to declare that they own an off-plan project? Does an American have to declare that they have an off-plan project in Dubai? No, off-plan no. See, the legal status of off-plan project is that you have given a deposit Right. For an asset you are yet to get, right? Or for a real estate you are yet to get. At this point, if you are a company just hypothetically, if a company gives buys a real estate project off-plan project, so on their balance sheet that is an advance they have paid, right? When you actually get your title deed and the title is transferred and you have the constructive possession of the property, that's when it's your property, right? Okay. But declaration it's a income tax return. The declaration is not for what you own. There are certain declaration for what you own, but your income tax 1040 return that you file is for your income. So, till the point you are not generating an income, there's nothing to declare. Okay. So, now we go to let's say a scenario. Now we have the title, right? But it's still not income generating. So, do I have to declare that anywhere? No. Not yet. Okay. Now we go and we sell it for capital appreciation. So, at that point, I have capital gains. Yes. That's where an American has to declare that. That is an income, yeah. Okay. How is that taxed for a US citizen not just capital gain, even if it is a capital loss you have to declare. Okay, thank you for clarifying. So, how is the capital gain in the UAE for a US citizen living in the US? How is that taxed? Okay, so see, it's it's just like any other gain. First thing we check is whether it's a short-term gain or it's a long-term gain. Okay, what's the difference? How do you differentiate the two? One year less than one year more than one year holding period, right? Sorry, if I could stop you. Holding period meaning if I take possession of it, project is finished and I hold it for a year, can I be renting it out in that year? Yeah, whatever you do. So, then if I hold it for more than one year, then that is considered a long-term capital gain if I sell it? And that's at a lesser point? That is at a lesser Okay, please. Okay, please. Okay. So, so capital short-term or long-term. Once it is deemed that okay, short it's long-term, then so there are certain slabs in US taxation depending on your filing status, married filing jointly, separately, single whatever and based on your income slabs for that. So, wherever you fall in that grid, income slabs and the and the filing status, that would be the percentage you will pay. If I recall correctly, the highest one is 25. So, generally that is lower than your regular income rates. Okay. So, you do have some advantage in terms of your capital gain compared to the regular income. Okay. But yeah, you have to declare that. Okay. So, now we're differentiating between holding it for a year and then long-term capital gain. Now, what about rental income? Is that taxed at a separate rate than capital gain taxes? Yes, so rental income is just like your ordinary income. Okay. Bracket it falls into, it will be taxed accordingly. Just your regular just like you get a W-2 income, similar to that whatever bracket it falls into, it will be taxed in that particular bracket. And not just that, I mean, let's suppose you had a W-2 of 100,000 and you had a rental income of 20,000. So, wherever that, you know, if tax slab is, you know, 0 to 90,000 certain rate, 90,000 to 120, certain rate, then whatever that rate is, that will apply to the 10,000 of W-2 plus 20,000 of your rental income. How can we decrease Okay. That taxable amount? That is the interesting part. Yes. And and honestly, there is no rocket science to it. It's simply the US law says that you have to have, you know, depreciation Okay. Taken on your rental property, right? For foreign property, the depreciation is 30 years. Okay. Okay. So, generally versus I'm sorry, versus what is it for domestic? Domestic is usually 27 and a half. Okay. Okay. So, generally plus domestic sometimes they are they are different incentives given by the government for bonus depreciation and all that which you don't get in the foreign one. Okay. So, generally speaking, your rental income, let's say you had We will talk in US dollars. Let's suppose you you had a million dollar property, you had a rental income of 100,000 US dollars and against that you have some expenses, repair, maintenance, maybe interest or whatever whatever expenses. The net net you are left with is let's say 20,000. Okay. Okay. But that you have a million dollar property for that you have to depreciate over 30 years. So, each year it is around 33,000. Okay. Right? So, 20,000 is your income before depreciation and when you apply depreciation it becomes minus 13, right? So, because it is minus 13, at the least it is not going to add any taxes to you which you otherwise had. But at the same time, you have an option to use that minus 13 towards reducing your W-2 income or whatever other income. So, that's where the the the you need to do something. It's not like you can do it right away on paper, there has to be something on ground. And is it the right time to Should we move to that topic? Absolutely. Okay. So, see, US tax differentiate between active income and passive income. Or the word they use is unearned income and earned income. So, earned income means your Sorry, earned income and passive income. So, earned income means your W-2 income or self-employment income which is technically an active income. You're doing something to get that income. Passive income is your dividend, passive income is your, you know, rental income. These are passive where you have just created some asset and it is generating its own money. So, if it is passive income, it cannot be used to offset your active income. Mhm. Right? So, in my example, that 13,000 that you have available as a loss cannot be used to reduce your W-2. Assuming in our case W-2 was 100,000. So, it cannot become 87,000, right? But somehow, if that income is active income from the same real estate, if that income is active income, then you can reduce it. So, how do we make that active income? Okay. Again, as I said, that will not happen on paper. You have to do something real. Okay. So, short-term rental, Airbnb, may be considered an active income if you meet certain criteria. Okay. Okay? So, first criteria So, see, when you fill your So, in your tax return, rental income goes in a schedule E. Okay. Right? Schedule E can have two different kind of rental income. One and rental income which is passive and which cannot offset. The second rental income is where you are doing active participation into as into that management of the real estate. Right? For X number of hours, we'll come to that. So, in that case, it can offset your active income. And the third category is if you are doing too much of the active work into that Okay. Then that goes not in your schedule E, that goes into your schedule C, which is your self-employed income and which is subject to social security and Medicare. Okay. So, you have to be careful to keep it in the right category. Be too aggressive into what you are doing because otherwise, if it is in your schedule C, there is an almost 15% of your social security Medicare employer and employee portion. So, where is that sweetest spot? That sweetest spot is when you we are doing Airbnb or Verbo or whatever, your average should be less than average stay should be less than 7 days. So, you can Okay, so average stay is the for calendar year or the fiscal year? How does that calendar year. Calendar year is less than 7 days, okay. So, so you cannot just list it on Airbnb and ask your tenant, "Okay, rent it for 1 year." Okay. Right? So, average stay has to be less than 7 days. Secondly, your participation into that activity provided nobody else is doing more than that. But how does someone even account for that? Okay. You have to keep a log. If the onus is on you to prove, right? And what is considered assuming your personal scenario, remote person who is sitting in US doing a work in US, he's not living in UAE and has a UAE property on Airbnb or Verbo. So, what will be considered his input? That would be, you know, communication with the guest, which can happen remotely, approving your repairs, coordinating with your vendors for cleaning and all that stuff, approving guest, doing the marketing for it on the port on on on Airbnb, creating different offers and all that stuff. So, whatever management you need to do in that sense, that all goes into your your work. That hours, that time. What if we hire a property management company? Is somebody else. Then you are So, then we can no longer have that as active income? Okay, so that's I'll come to So, see, 100 hours or more provided you have done the maximum work. Okay. But that is tricky sitting in US because let's suppose it's the shortest stay, right? Every week. Okay. So, hypothetically, if you had 40 different customers, I mean 40 trips. So, that means and then after that after every person goes out, you do a cleaning. You get someone to do a clean. Whether that's a property management company or that's a direct person, whoever it is, someone is doing a cleaning. So, that cleaning is let's suppose taking 2 hours, right? So, 40 * 2 is 80. Still less than you, but let's suppose the same person has also done the repairs or the same company has also done the repairs. Another couple of hours, right? So, the point is when you do 100 or more, nobody should do more than you. And which is difficult to do while you are sitting there. Okay. Because I'm saying cleaning 1 hour, it might not be 1 hour. It might be 2 hours. It could be a big villa. It could be something else, right? There could be big repair work to be done or there could be someone to manage the property, right? They have their own hours. So, 100 is where you you can claim that, but then you have to make sure that you are doing the maximum work. Okay. If that cannot happen, then cross 500. How you will do it? You have to think about it. Criteria is same, but if you cross 500, Okay. That's where anybody can do anything. It doesn't have to be maximum. Okay. 500 hours means IRS assumes that you have done enough work that it is not passive anymore. Okay. Right? Okay, that makes sense. This opportunity to use that extra loss. And in most of the scenarios when we incorporate depreciation, there is a loss, right? So, when you have that extra loss, you can use that part to offset your W-2 income. So, that is the sweetest spot you have to operate in. First of all, it has to be a real Airbnb short-term stay, less than 7 days, your contribution should be more than 500 hours, and just a caution, usually tax law is very complex. There are too many conditions. These are the two major ones I discussed. Do not act upon it just by yourself. Talk to an accountant before you go for that strategy, specifically for your situation at that time. Even if you come to me or whoever, that accountant can look into your situation, look go into all the conditions, and then give you a overview, "Okay, you have to meet A, B, C, D, and then you are able to do it." Let me ask you, in that scenario, if they do use the depreciation scenario for their short-term rentals, does that come back to bite them once they're selling? Big time. So, when you do the depreciation, it increases your future capital gain. So, for example, our general thinking is that if I bought something for, let's say, $10 and I'm selling for $16, so the gain is $6. But if you are taking the depreciation year over year, and by the time you sell, your depreciation is four $3. So, now your gain is 6 + 3 9. So, technically, that is reducing your The legal word is The technical word is basis in that asset. So, your basis were 10. Now, that basis are because you already took the advantage, so the basis have reduced to seven or what Yeah, seven. So, so then 16 - 7, 9 is your capital gain. So, that it is actually going to enhance your capital gain. So, the advantage you are getting you are getting in each given year, but when it shoots up, it shoots up in one particular year. Yes. But we have another good news. What's the other good news? Okay, so the good news is Please, taxes and good news, I don't know if that goes together. Usually, I'm considered the bad news source for my clients. So far, it's been depressing, depressing, depressing. Yeah. So, Okay, so the good news is we have heard about 10 1031 like-kind exchange, right? It's com- fairly common in US. But it can be done in a foreign property as well. Again, there are few conditions attached. I will discuss few of them, not all of them. So, most important condition is it can be foreign to foreign, which means if you have a property in Dubai, you can buy property in London, you can buy property in Spain, but not in US. And likewise, if you're selling in US, you cannot buy in Dubai. So, like-kind exchange means it has to be foreign to foreign. You have to follow those number of days requirement within which you have to inform and within which you have to buy a replacement, and that is a very short time. So, considering everything and considering you are based in US, you might may or may not have to come, you know, all of those factors will come into play. Even bigger factor would be there has to be a qualified intermediary. So, finding a intermediary who can take care of that for a UAE property, obviously, you wouldn't want to move your money due to exchange rate back and forth what you want to do. So, yeah, so that would be another challenge to find a qualified intermediary. I And I if I may, I actually have a podcast episode with a licensed intermediary for 1031 exchange who's based here. So, I'll I'll link that below. Oh, yeah, that would be great. So, so yeah, as long as you meet those conditions which are pretty similar to your normal domestic 1031, as long as you are able to meet those conditions, you can do 1031. So, it can defer your tax. Obviously, there is no tax-free lunch. Like the common saying, there's no lunch. I say there is no tax-free tax-free lunch. Actually, I'm going to use that. There's no tax-free lunch. Okay, Amir, there's another question that's coming up after Well, first of all, let me just really you don't have any great news, okay? You're going to pay taxes as a US citizen unless you give up your passport, and you can't even give in that give that up just for the sake of not wanting to pay taxes, right? Giving up is not free in such situation. Exactly. And the truth of the matter is my focus with my American clients and Canadians is that there are no property taxes in Dubai. There are no additional capital gains taxes in Dubai. Your money is sent back to you to do as you need to do legally in your country. And there's there aren't these opportunities to get into the real estate market at these prices and benefit from the capital appreciation returns, long-term rental 6 to 9% and short-term Airbnb opportunities. And there is no tax return to be filed here if you own it individually. So, there's no I mean, even if there's a foreign tax Let's suppose you buy property in some Let's say, Canada, right? So, okay, you have a foreign treaty, foreign tax credit, but then you have to pass through two different hoops. And at that time, by the way, exchange rate is also an important factor you have to consider. Yes, but US Canadian Sorry, UAE Canadian UAE US exchange rate is pegged. So, you won't see much impact, but I have seen the real cases in case of US Canada. Somebody bought property, you know, back in 5 years back, and they sold it last year, and exchange rate was through the roof. They thought that they have a loss, but when we considered because when we are calculating capital gain, it is the exchange rate on the date of purchase times US dollars or whatever currency, exchange rate on the date of sale times whatever currency. A really good point. I've never because it's been a fair, it hasn't become an issue, but that's It's advantage for Americans. People, you know, in California only, where they they bought it, they sold it. Technically, it was a loss in a US dollar terms, but so they were filing for Canada. So, in in Canadian term, that was a gain. So, yeah, it can happen and that that that is really a bad news because you already made up your mind, okay, it's a loss and that's a genuinely a loss. Right. Realize and now you're paying on that loss. Yes. So, now going to another question I'm asked very often and I have had multiple experts from the Dubai Land Department government official to UAE attorneys, etc. On here, but I'm going to ask you. Mhm. Is there an advantage for a US citizen to purchase a property in Dubai under the name of a corporation here in Dubai from a tax minimization per perspective? Okay. From tax minimization, I don't see any advantage, rather it could become it would make your tax return complex. Why? Okay, so when you own a corporation and you are a US person living in US or even not living in US. If you own a corporation and you are filing a 1040, that's corporation is outside US, that is considered controlled foreign corporation, CFC. Okay. And then you need to file a 5471 form and I would request all your readers who plan to do that, first download that form before doing anything. Oh, really? Download that form. Just see that is just a part of 1040. Just see how many schedules it has. It has five filing categories, not that marriage filing single and all that. Category A, B, C or 1, 2, 3, 4, 5 and each category has different type of schedules you need to fill in, which includes P&L and balance sheet of that corporation and it may translate into additional tax for you. It may. Generally speaking, if that foreign corporation is doing an active business, again, Airbnb comes into play, but generally speaking, if it's doing an active business, possibly less impact, but if it is doing a passive income, if that corporation is getting a passive income, it is taxed much severely, right? So, for a US person, corporation doesn't solve because the whole point of corporation from tax perspective is that there's a separate legal entity, it has its own tax return and everything within US, within domestic corporation for a C corp, yes, that makes sense. I mean, that is separate In the United States. Yeah, yeah, within US, a C corp is a separate entity, it has its own tax return. But when it comes to controlled foreign corporations, US says, we don't care. You have not taken profit, you are trying to defer it, no way. You have to pay it now. Got it. Having said that, if it's an as I said, if it's an operating income or if you are you are that corporation is in a country where the tax rate is much higher, like Canada, possibly it will not it will be additional filing, but it will not affect you from tax point of view. Okay. But from country like UAE, yeah, it can affect. Okay. But for asset There may be other reasons and benefits, such as asset protection, but thank you for answering the question about from a tax minimization. Really, there's just no way to get away from it. You have to look at Dubai and the UAE as a opportunity to make money and not to escape paying Uncle Sam. Yes, when a US client comes to me and say, I want you to minimize my taxes, what I usually tell them is I can ensure that you don't get a IRS penalty. I can ensure that you are compliant for those complex cases. You are compliant, but minimizing taxes is there's not much I can do unless you have forgotten something, unless you don't you are not already aware of. For example, US people living in UAE, they have they are entitled to what is called foreign earned income exclusion, again, subject to terms and conditions. If somebody doesn't know about it, I can tell them, but if he already knows about it, there are other laws I have to follow. Well, I'll actually do another episode on that cuz that would apply to me, actually, and I would like to learn more about the foreign earned income credit scenario for myself working in Dubai, but thank you, Amir. I think this has been a very important segment. We are seeing and I think you were saying this before the podcast, how many Americans are purchasing in Dubai, moving to Dubai. So, we're seeing record numbers and so this is going to come up because it is a pain in our thighs, okay? I'll just say that. But come to Dubai, habibi, you'll make money, but you still have to pay those taxes if you are that American passport Yeah, don't upset Uncle Sam. So, thank you for tuning in. I hope that that answered most of your questions. If you have more, please feel free to comment, make sure to like, subscribe, follow and watch the next episode of The The Dubai Connect Podcast. Until then, happy investing.