Non-Resident Aliens Owning U.S. Rental Real Estate
Unreported Income – IRS is Aware. Heavy Penalties Await the Unwary
Written by Steven Miller, CPA January 27, 2018
During 2017, a Treasury Inspector General for Tax Administration, TIGTA, reported there had been a severe lack of compliance where Nonresident Alien [NRA] individual landlords own U.S. rental properties.
TAX ELECTION STATEMENT
The audit estimated NRA investments in U.S. real estate increased from $34.8 billion in 2013 to $43.5 billion. In a test sample, the TIGTA audit found 68% had failed to attach a tax election statement to their return.
The consequences of failing to attach the tax election statement in the year of the purchase of the property can be extreme.
Instead of being able to deduct all typical rental property expenses against the rental revenues earned, the NRA must pay a flat 30% of all gross rental revenues to the government.
Typically this means the NRA landlord goes from a net taxable loss to owing a lot of money to the government.
NONRESIDENT ALIEN OWNING & DERIVING INCOME
Nonresident alien individuals who own and derive income from U.S. residential real property can elect to treat rental income generated by these properties as effectively connected to a U.S. trade or business.
The election allows them to reduce their rental income by offsetting rental expenses related to the rental activity including such items as real estate taxes and depreciation.
USING MANAGEMENT COMPANY
Another problem is NRA property owners often hire a real estate management company to oversee the rentals and collect the rent. The management company can be held liable by the IRS for the 30% tax withholding if the IRS discovers the tax due.
Real estate management companies are at extreme risk since they rely many times on the forms filed by the NRA landlord without further checking on the document’s veracity.
PROBLEM IS AVOIDABLE
These problems are avoidable when working with tax professionals experienced in dealing with U.S. real property and non-US owners.
Many NRAs believe merely setting up a U.S. LLC [Limited Liability Company] solves their issue. It does not.
The IRS “looks through” the LLC to the owner of the LLC and applies the complex set of laws referred to as FIRPTA. FIRPTA is the foreign investment in real property tax act and has many rules that govern the taxation of U.S. real property owned by foreign nationals and foreign entities.