Three tax traps for foreign owners of US real estate

Many non-resident aliens invest in US real estate, which can be complicated from a tax perspective. These complications include potential exposure to US estate tax as well as tax and information reporting obligations, which are described in more detail below.

Property tax

A quick search might lead you to believe that U.S. estate tax does not apply to real estate owned by a nonresident alien as long as the value of the real estate does not exceed $12,060,000, which is to the 2022 US estate tax exemption amount. However, this generous exemption is only available to resident aliens or US citizens. A deceased non-resident alien is only entitled to an exemption of $60,000, with any amount over that exemption being subject to estate tax at rates ranging from 26% to 40% for estates with a value of greater than $1 million. In South Florida, a hub for foreign investment, the average fair market value of a single-family home can easily exceed $1 million, resulting in a large tax bill that must be paid nine months after death. If the estate does not have the cash to pay the tax, this can present a difficult situation. During this time, there may be an accumulation of penalties for non-payment if the estate is not yet settled and is unable to release the cash or sell the home to pay the tax in time. timely to the IRS.

With proper planning, the issue of inheritance tax and cash flow can be resolved.

Filing requirements and payment of tax

Even if a U.S. property produces no income or has no activity, if it is owned by a business entity, the business entity or trust may be required to file annual federal and sometimes state income tax returns. If a foreign person is the lessor of U.S. property or the recipient of rental income from it, and is not exempted by a treaty, the foreign person must file a Form 1040-NR, Income Tax Return non-residents of the United States for that income. Failure to file penalties, failure to pay penalties, estimated tax penalties, accuracy penalties and related interest are all possible if there are classification errors.

Federal income tax is not the only type of tax possible. States may impose their own income tax or franchise taxes for the privilege of doing business (owning property) in the state, tangible income reporting requirements, and some cities have their own tax requirements. income tax and reporting. Many states and cities levy sales tax on rents from commercial properties or short-term rental properties and impose additional taxes on short-term rental properties such as tourist, occupancy, transient or other taxes ; excise tax; or the tax on gross receipts. These taxes sometimes require monthly or quarterly tax returns even if the tax or income for the current period is zero. States and cities impose their own penalties, similar to the federal penalties mentioned above.

Depending on the structure chosen and the residency status of the various entities and individual partners, shareholders or beneficiaries, several international information reporting forms may need to be filed with the IRS or the Financial Crimes Enforcement Network (FinCEN). Penalties for not filing, filing late, or incorrectly filing these forms are significant, ranging from $10,000 to $25,000 initial penalties per form per year, continuation penalties of $50,000, or sometimes a percentage of the outstanding balance. an account or the transfer amount. Common international information reporting forms required are FinCEN 114 (FBAR); Form 8938 declaring foreign bank accounts or assets of US persons (a US entity is a US person); and Form 5472 declaring foreign ownership of a U.S. corporation or declaring a foreign corporation doing business in the United States

Rental income paid to a foreign person is subject to withholding at source and the filing of an information return by the source officer. Often the intermediary of the entity is responsible for this task and failure to do so may make the withholding agent liable not only for the foreign person’s tax, but also subject the withholding agent from withholding to penalties for failure to report, pay and file.

Once the penalties are imposed and start accumulating, the IRS and the state Department of Revenue can put a lien on the property, collect rental income, or even seize and sell the property at auction. Nonresident aliens with a federal tax lien may have their information shared with the Department of Homeland Security.

Worldwide income tax

Owners of property in the United States may be tempted to visit the United States often. However, staying in the United States for more than 183 days in a three-year period may make you a U.S. resident for tax purposes, subjecting you to tax on your worldwide income and often requiring additional filings of information for tax purposes. foreign companies, assets, bank accounts, etc. ., even if they are not related to US real estate. Due to the way days are calculated under the substantial presence test,1 if you ensure that you stay below 120 days of attendance each calendar year, you cannot subject yourself to US tax via this test. Indeed, when calculating whether 183 days of presence have elapsed over a three-year period for the purposes of the substantial presence test, only 1/3 of the days in the tax year immediately preceding the year of declaration of current income is counted, and only 1/6 of the days of the year preceding the immediately preceding year are counted when added to the days of the current tax return year.

However, there are ways to not be considered a US resident for tax purposes even if you exceed 183 days of physical presence in a three-year period. The Substantial Presence Test has a specific formula for counting days present in the United States, with certain days excluded for medical reasons, transit, certain commuting, or other purposes. There are also other options for certain foreign persons whose countries of citizenship have a treaty with the United States with a tie-breaking provision. Alternatively, if a person has a closer connection to a foreign country than the United States and has not taken steps to become a U.S. person (“closer connection” test), in some cases that person may be able to claim that there is no residence in the United States for tax purposes.

1Substantial presence test


Our current issue: Q2 2022