What Tax Issues Should U.S. Persons Consider When Establishing a Company in Japan to Engage in Real Estate Leasing?

As the Japanese yen continues to weaken, many Taiwanese investors are actively entering the Japanese real estate market. However, for investors who are also U.S. tax residents, more complex cross-border tax issues may arise. This article explores the key U.S. tax considerations by using the example of a U.S. tax resident who establishes a company in Japan to manage and lease real estate.

U.S. CFC rules

When a U.S. person (U.S. shareholder) establishes a company in Japan (hereafter referred to as the “Japanese company”) and engages in real estate leasing as the primary business activity, the related tax planning and filing obligations in both the U.S. and Japan can be quite complex. One of the most important issues is the U.S. Controlled Foreign Corporation (CFC) tax rules. Particularly when rental income is the company's main source of revenue, a key planning question is whether this income must be included in the U.S. shareholder's current year taxable income.

To begin with, if the U.S. person establishes a Japanese company—such as a Kabushiki Kaisha (KK) or Godo Kaisha(GK)—and owns 100% of its shares, that company will be considered a CFC under U.S. tax law. According to the U.S. Internal Revenue Code, a foreign corporation is a CFC if more than 50% of its shares are owned (directly or indirectly) by U.S. persons who each hold at least 10% ownership. In this case, the U.S. shareholder would be required to report the Japanese company as a CFC by filing Form 5471.

Subpart F income

Moreover, under the Subpart F rules, rental income and other types of passive income may be classified as Foreign Personal Holding Company Income (FPHCI). In such cases, even if the Japanese company does not distribute dividends, the U.S. shareholder is still required to include the income of the Japanese company in their U.S. taxable income based on their ownership percentage (100% in this example).

At this point, many may wonder: should U.S. persons avoid establishing foreign companies or investing in foreign real estate altogether to avoid the complexities of CFC reporting? The answer is: not necessarily.

Exception of Subpart F income

Not all rental income is automatically treated as Subpart F income. If the Japanese company engages in substantial real estate operational activities—such as employing local staff, maintaining an office, and holding reasonable capital assets—then the rental income may qualify as active rental income, which is an exception under the Subpart F rules. This exception can significantly reduce the U.S. shareholder's tax burden.

For example, if the Japanese company is genuinely engaged in the real estate leasing and management business locally in Japan—handling advertising, tenant communications, leasing contracts, repairs, rent collection, etc., through its own employees rather than outsourcing—then the rental income may be deemed to arise from active business operations. As such, it would not be treated as Subpart F income, and the U.S. shareholder would not have to include it in their current-year taxable income.

Conversely, if the Japanese company does not conduct real business operations and merely holds real estate assets in name, while outsourcing management to other companies or individuals, the rental income is more likely to be classified as passive rental income, and therefore subject to Subpart F taxation.

For example, if the Japanese company earns JPY 30 million in rental income in a given year, with JPY 15 million in net income after expenses, and the U.S. shareholder owns 100% of the company, then—assuming an exchange rate of JPY 150 to USD—the U.S. shareholder would need to report USD 100,000 in Subpart F income on their U.S. tax return. This amount must be included in their U.S. taxable income and disclosed in detail on Form 5471.

GILTI tax consideration

In addition to the Subpart F rules, U.S. shareholders of a CFC must also consider another provision introduced by the Tax Cuts and Jobs Act of 2017—the Global Intangible Low-Taxed Income (GILTI) regime. GILTI is designed to prevent U.S. persons from accumulating profits in low-tax jurisdictions. Even if the Japanese company is engaged in a real business, if its return on tangible assets exceeds a certain threshold—typically 10% of its Qualified Business Asset Investment (QBAI)—the excess income may be classified as GILTI and taxed in the U.S., even if not distributed. For individual U.S. shareholders, the tax rate on GILTI can be as high as 37%.

Conclusion

If a U.S. person establishes a company in Japan to engage in real estate leasing, they should ensure that the Japanese company meets the substantial business activity requirements. Doing so not only improves business operations locally in Japan but also ensures compliance with U.S. international tax rules while minimizing U.S. tax liabilities. For high-net-worth U.S. individuals participating in Japan real estate market, this strategy can be a practical and effective approach to cross-border investment.