Owning Real Estate Outside the USA
While the USA has a set of complex rules for foreign persons owning real estate in the United States, it is often overlooked that many US citizens and resident aliens own real property outside of the country. The amount of the potential tax reporting that may be required for these individuals can be both surprising and alarming.
Also consider the penalties for failing to file the proper tax forms are extreme. The IRS and the FATCA regulations have added a number of reporting requirements and tax forms. Many penalties start at $10,000. There are many advantages to paying attention and proactively planning. A typical question is “Do I have to report my real estate I own in a foreign country in my US tax return?”
Your individual facts and circumstances define what reporting and tax forms may be required. Don’t forget you may have additional income tax deductions associated with the foreign property.
Also consider what connections to the foreign real estate may require other reporting. If you own real estate outside the USA, you typically have one or more bank accounts in that foreign country. That creates disclosure on your Form 1040, Schedule B that asks if you have any foreign bank or securities accounts. Now you have to answer, yes. If the highest balance in that account(s) was $10,000 or more at ANY TIME during the calendar year, you must file the Form 114 Report of Foreign Bank Accounts. This form must be filed electronically with the Financial Crimes Enforcement Network [FINCEN] annually before July 1. Failure to do so risks penalties beginning at $10,000 and potential criminal indictment.
Now back to the real estate question. One very important question is HOW do you own the real estate? Ownership of real property is often set up so the owner is a foreign corporation rather than owned by the individual. But you may experience all kinds of forms of ownership. A Land Trust is a popular entity to own and hold Mexican real property especially near the coasts.
But here is the catch. If you purchased the real estate and placed the title and ownership inside a corporation (i.e. foreign corporation) then you typically will have a CFC – a controlled foreign corporation. You must include a Form 5471 to your tax return as the owner of any CFC. Penalties for failure to do so begin at $10,000 for each year you failed to file the form.
Owning foreign real estate within any type of entity typically forces you to report that ownership on one of a number of IRS forms including the new Form 8938 – Statement of Specified Foreign Financial Assets. This form is one of the forms from all of the FATCA laws recently enacted. 2011 was the first year this form was required on US income tax returns. Penalties begin at $10,000 per incident. Keep in mind that there are reporting thresholds for Form 8938 and if your total foreign financial assets do not exceed those limits, you are off the hook for filing that year.
IF you own your foreign real estate directly as an individual, there is good news. You do not have to report that property on Form 8938 or other FATCA forms even if it is a rental property. Any real estate taxes you pay on that property may be deducted on your itemized deduction schedule on your Form 1040.
If you own the property directly AND you are renting it out, don’t forget to report the rental property on your personal US income tax return. Don’t pull a Charlie Rangel, former chair of the House Ways & Means Committee who left off a number of foreign rental properties from his tax returns for years.
If you inherited the property, determining the fair market value on the decedent’s date of death provides your adjusted tax basis in the property. Under certain circumstances, you may be required to file a Form 3520 to report a distribution from a foreign trust, foreign estate or gift from a foreign person in excess of $100,000 during the year. Penalties for failure to file this form begin at the greater of $10,000 or 35% of the distributions received. So a $200,000 transfer of property would incur a $70,000 penalty.
Selling the property for a gain may create a taxable event in the foreign country. You would also report the sale on your US return with a possible foreign tax credit offsetting some or all of the US tax on the gain. This varies greatly among various countries so you want to know what the rules and tax rates are for a sale BEFORE you buy.
If the foreign property was your personal residence, you may be eligible for exclusion of your gain on your US tax return if you meet the 2 years out of 5 test for residing in the home.. This applies even for a foreign home. But again, beware of the local tax rules on the sale of such property. In summary, there is no substitute for planning and strategy. Look before you leap and understand what you are getting into. If you are just now realizing you have a problem, don’t bury your head in the sand. Get assistance immediately.