IRC 2105: Property Outside the United States

The United States government imposes an estate tax on the assets of deceased individuals. For U.S. citizens and residents, this tax applies to their worldwide assets. For non-resident aliens (NRAs), the U.S. estate tax applies only to assets considered “situated” within the United States. The legal location of property for tax purposes, known as its “situs,” is the determining factor for an NRA’s estate.

Defining Property Outside the United States

Internal Revenue Code (IRC) Section 2105 provides specific definitions for property considered to be located outside the United States for estate tax purposes, even if there appears to be a connection to the U.S. These rules create important exceptions for non-resident aliens. The law is designed to exclude certain assets from taxation to encourage foreign investment in the U.S.

Proceeds of Life Insurance

An exclusion from U.S. estate tax is the proceeds from a life insurance policy on the life of a non-resident alien. The amount receivable from such a policy is not deemed to be property within the United States. This rule applies regardless of whether the insurance company is a U.S. or foreign entity. The location of the policy or the beneficiary’s residence does not alter this treatment, as the key is that the policy insured the life of the NRA decedent.

Certain Bank Deposits

Certain cash deposits are also treated as property outside the United States. This includes deposits with U.S. banks, savings and loan associations, and amounts held by insurance companies, provided the interest earned on these deposits is not “effectively connected” with a U.S. trade or business. This provision extends to deposits held in a foreign branch of a U.S. commercial bank. The purpose is to allow NRAs to use the U.S. banking system without subjecting those funds to estate tax.

Works of Art on Loan for Exhibition

A special rule exists for works of art owned by a non-resident alien. Art imported into the U.S. solely for exhibition purposes is not considered U.S. situs property. To qualify, the art must be on loan to a public gallery or museum. At the time of the owner’s death, the artwork must be on exhibition or in transit to or from an exhibition at such an institution.

Certain Debt Obligations

The treatment of debt obligations, such as bonds, is nuanced. Generally, debt obligations of a U.S. person, the U.S. government, or a domestic corporation are considered U.S. situs property. An exception exists for “portfolio debt.” If the interest on a debt obligation would have been eligible for the portfolio interest exemption under IRC Section 871 had the decedent received it, the obligation is not considered U.S. property. This allows NRAs to invest in many U.S. bonds without triggering U.S. estate tax.

Stock in Foreign Corporations

The situs of corporate stock is determined by the location of the issuing corporation’s incorporation. Stock in a corporation organized outside the United States is considered property outside the U.S. for estate tax purposes. This holds true even if the foreign corporation’s assets are primarily located in the U.S. or if the physical stock certificates are held in a U.S. brokerage account. This rule allows NRAs to hold U.S. assets through a foreign corporate structure to avoid direct U.S. estate tax exposure.

Property Subject to U.S. Estate Tax

While IRC Section 2105 outlines what is considered property outside the United States, IRC Section 2104 defines the assets that are considered situated within the U.S. and are therefore subject to estate tax for a non-resident alien. For NRAs, only the value of these U.S. situs assets is included in their gross estate for tax calculation. They are only entitled to a tax credit of $13,000, which exempts just $60,000 of assets from the tax.

Real estate physically located within the United States is U.S. situs property. This includes residential homes, condominiums, commercial buildings, and undeveloped land. The physical presence of the property within U.S. borders makes it subject to the estate tax if held directly. The value included in the estate is its fair market value, which is not reduced by any mortgage on the property for situs determination.

Tangible personal property located in the U.S. at the time of the NRA’s death is also included in their taxable estate. This category encompasses items like vehicles, boats, jewelry, furniture, and physical currency. An exception exists for personal property that is merely in transit through the U.S. The key factor is the property’s physical location at the date of death.

Stock in a U.S. corporation is considered property within the United States, regardless of where the physical stock certificate is located. If a non-resident alien directly owns shares in a domestic corporation, the value of that stock is subject to U.S. estate tax. This rule often surprises foreign investors who hold their U.S. securities in a brokerage account in their home country.

The Role of Tax Treaties

The situs rules defined under the Internal Revenue Code are not always the final authority. The United States has entered into estate and gift tax treaties with several other countries. These treaties can alter the tax obligations of a non-resident alien by providing different rules for determining asset situs, offering more generous exemptions, or establishing credits to prevent double taxation. When a treaty is in effect, its provisions override the domestic tax laws outlined in IRC Sections 2104 and 2105.

For example, while U.S. domestic law considers stock in a U.S. corporation to be U.S. situs property, a tax treaty might change that rule. A treaty could specify that the situs of corporate stock is the decedent’s country of domicile, thereby removing it from the U.S. estate tax base entirely.

These international agreements can also provide a larger, pro-rata version of the unified credit available to U.S. citizens, which is more substantial than the standard $60,000 exemption for NRAs. A treaty might allow the NRA’s estate to claim a portion of the larger U.S. exemption based on the ratio of their U.S. assets to their worldwide assets. This can reduce or even eliminate the U.S. estate tax liability. Therefore, it is important to determine if a tax treaty exists between the U.S. and the decedent’s country of domicile.