US Estate Tax – What is “Situs”? Location of Assets Makes a World of Difference

My recent and upcoming blog posts are examining the US estate tax and how it often comes as an unwelcome surprise to the foreign investor in the US and to the foreign heirs when the investor passes away.  The family is often left to clean up the mess if the investor has not properly planned for the US estate tax.  This happens more often than one can imagine.  First, let’s look at some US estate tax basics and then move on to some of the highly nuanced rules that impact the foreign individual who wishes to invest in the USA.

Overview

The US Estate tax rules apply to a US person (US citizen or “resident”) differently than to a non-US person (non-US citizen who is also non-US resident). The estate of a non-citizen who is treated as US “resident” will be taxed on the fair market value of all of the worldwide assets owned by the individual at the time of death (or an alternate valuation date). On the other hand, if the non-citizen is treated as “non-resident” of the US at the time of death, the estate will be subject to the US Estate tax only on assets located, or deemed to be located, within the US. These are often referred to as “US-situs” assets.

Estate Tax Exemption Amount and “Domicile”

A very generous exemption from Federal estate tax, based on the value of assets in the estate, exists for a non-US citizen who is treated as a US “resident” This exemption amount is US$13.6 million in 2024.  On the other hand, only a paltry exemption (USD60,000) exists for the foreigner who is not treated as a US “resident”.  Tackling this complex issue of “residency” for US estate tax purposes is obviously very critical.

“Residency” for US estate tax purposes does not use the same test as “residency” for income tax purposes. The test looks to whether the foreign individual was “domiciled” in the US at the time of death.  If so, the decedent’s estate is treated in the same manner as that of a US citizen (simply put, worldwide assets are taxed and the generous exemption amount applies).

Let’s repeat it: “domicile” governs whether (i) worldwide assets or only US-located assets will be subject to US estate tax and (ii) a large or meager exemption in dollar value of assets will be permitted. This is a very important point for non-US persons who are buying properties or having other investments in the US. If they die owning such properties, the US Estate tax can be assessed on the fair market value of the property (maximum 40% current rate).  The issue of “domicile” under the Estate tax rules can be found at my blog post here.

Due to the complexity and uncertainty in determining one’s “domicile”, proper planning is very important. Planning before purchasing US-situs assets can help mitigate the uncertainty and potential tax hit that is associated with a finding that the decedent was not a US domiciliary at the time of death.

“Location” or “Situs” of Assets – A Few Quirks

If it is determined that the foreign national decedent was not domiciled in the US, the estate tax analysis shifts to the situs or location of the decedent’s assets. Foreigners not domiciled in the US are generally subject to US estate tax only on their assets “situated in the United States” at death.

For certain assets, complicated rules apply to determine the location (or “situs”) for US estate tax purposes.  Tangible personal property (a diamond ring, a fancy sports car) or any real property located in the US is considered to have a US-situs.  That’s easy to comprehend since taxation is based on the fact that these assts are physically located in the US.

The US tax rules are riddled with nuances, though, and this is a big reason why one needs to work with a qualified international tax professional. Here’s an example of such a nuance – works of art owned by a foreign individual who is not domiciled in the US are not treated as having a US situs even if physically located in America at the time of death, if certain conditions are met.  These are that the artwork was (1) imported into the United States solely for exhibition purposes; (2) loaned to a public gallery or museum; and (3) at the time of death, was either on exhibit or in transit to or from an exhibition.

What about intangible property?  Where is the situs for an intangible asset?

Stocks, Coops, Condos

Intangible property – such as stocks (including stock in a cooperative apartment), American Depositary Receipts, debt instruments, bank deposits, cash, life insurance proceeds, copyrights and so on, lead to far more complicated rules.  Below is a just a taste.  Next week’s blog post will look at situs rules for other intangibles.

Stock in any US corporation is deemed to have a US location regardless of where the share certificates may be held; but stock in a non-US company is treated as having a location outside the US regardless of where certificates may be located.

Ownership of a cooperative apartment located in the US is represented by stock in a corporation.  This stock will be treated as having a US location for estate tax purposes even if the share certificates are kept abroad. Cooperative apartments (“coops”) differ from condominiums (“condos”) in several ways.  When one buys a coop, the purchaser buys stock in the corporation that owns the apartment building.  The coop apartment is then “leased” to the buyer under a long-term proprietary lease.  The coop owner will pay a monthly maintenance to the corporation for operating expenses, property taxes and the underlying mortgage on the building (if it is mortgaged).  On the other hand, when buying a condo, one purchases an individual parcel of real property, such as an apartment or townhouse.  The condo building is divided into individual condos and common areas.  The owner of a condo owns his own apartment plus an undivided interest in the common areas.  The value of both US coops and condos will be subject to US estate tax as both are US-situs assets.

ADRs

In Private Letter Ruling 200243031 (July 25, 2002) the US Internal Revenue Service determined that American Depositary Receipts (“ADRs”) should not be included in the gross estate of a nonresident alien decedent.  American Depositary Receipts are negotiable instruments issued and sold by US banks. They are essentially stocks that trade in the United States, but the ADRs represent a specified number of shares in a foreign corporation located in a foreign country. An example might be Alibaba (BABA).

Just like typical US stocks, ADRs are bought and sold on US markets; they can trade in US dollars and clear through US settlement systems. This allows investors in ADRs the ability to circumvent fees and inconveniences of making transactions in foreign currencies (e.g., ADRs were developed precisely to bypass difficulties associated with trading at different prices and currency values).  In the usual case, a US bank will purchase a bulk lot of shares from a foreign company, bundle the shares into groups and reissue them on a US stock market such as the New York Stock Exchange.  Thus, despite being registered and issued generally by US banks, ADRs represent shares of stock in foreign corporations and should be treated in the same manner for US estate tax purposes.

Mutual Funds/ETFs/UCITS

If the foreign individual is not necessarily interested in holding specific US stocks, the US estate tax dilemma can be mitigated by investing in non-US pooled investment vehicles. These would include such products as foreign mutual funds, foreign ETFs, or similarly structured foreign products such as UCITs (Undertakings for Collective Investment in Transferable Securities). The foreign vehicle itself would invest in the US products that provide the foreign individual with his or her desired US investment strategies.

Broadly speaking, the place where the fund is incorporated and domiciled is the relevant consideration in determining if the individual’s ownership interest in the fund will be treated as having a US-situs and thus part of his taxable US estate.  For example, the foreign individual’s ownership in an offshore fund set up in Ireland which invests solely in US strategies would not ordinarily be subject to US estate tax.  On the other hand, the foreign investor’s ownership in a US mutual fund that invests solely in foreign strategies would be subject to the US estate tax.

Posted February 1, 2024

All the US tax information you need, every week –

Named by Forbes, Top 100 Must-Follow Tax Twitter Accounts @VLJeker

Named by Bloomberg, Tax Professionals to Follow on LinkedIn

Subscribe to Virginia – US Tax Talk  to receive my weekly US tax blog posts in your inbox. My blog specializes in foreign and US international tax issues.

You can access my papers on the Social Science Research Network (SSRN) at https://ssrn.com/author=2779920