Foreign Rental Income & IRS Tax Reporting – Summary Review Guide
Foreign Rental Income: The impact of Foreign Real Estate on U.S. Tax Law, FBAR and FATCA can be very serious, and costly. Many people misunderstand the IRS requirements regarding the reporting of Foreign Rental Income.
Foreign Rental Income
Foreign tax laws involving rental income vary depending on which country the rental income is earned in. This is because in many countries, there are minimum threshold requirements before real estate income has to be reported on a foreign tax return.
This is true in many countries such as Korea and South Africa. As such, in countries with a minimum threshold requirement, individuals can earn a certain amount of foreign rental income “tax free,” since because until they meet the foreign jurisdiction’s reporting threshold, they do not need to report the income.
IRS Tax on All Foreign Rental Income
Unfortunately, from the IRS’ Tax perspective there is no de minimis requirement regarding the reporting and taxation of foreign real estate income – all rental income must be reported.
This can get individuals who own foreign rental property into trouble with the IRS, especially when there are other assets or foreign accounts associated with the real estate income (aka FBAR or FATCA)
The following summary will breakdown the most common issues involving Foreign Rental Income:
Typical Example: Unreported Foreign Rents
David owns rental properties overseas. The properties generate significant income, but by time the deductions are applied, there is not much net income — and therefore it is below the threshold requirement for having to report the net income in the foreign country.
Since David is a Legal Permanent Resident in the United States (aka Green Card Holder), he must still report this information on his U.S. tax return. Depending on whether David is actively engaged or not in the management of property and/or owns the property as an individual or not, he would typically (but not always) report the income on a schedule E — either page 1 or page 2.
The United States requires taxation on worldwide income a.k.a. Citizen-Based Taxation or “CBT.” Citizen-Based taxation is more of a misnomer because it involves both citizens, Legal Permanent Residents and Foreigners who meet the Substantial Presence Test.
If you fall into one of the three aforementioned categories you are required to report your worldwide income to the United States. If you reside overseas and/or paid foreign tax, you may qualify for certain credits or exclusions, but that does not eliminate your requirement to file and report the income.
Foreign Real Estate Impacting U.S Income or Deductions
Even though the amount of income may be minimal, it can still impact a US tax return.
For example, depending on the amount of income David earns, it may increase David’s U.S. tax bracket and push him into the next tax bracket. In addition, the increased rental income may decrease the deductions allowed for “actively participating in a passive activity,” which begins to phase out after David earns $100,000 a year – and completely phases out at $150,000.
While real estate itself is not reported on an annual FBAR statement, the accounts that are used to hold the income abroad (such as foreign rentals) must be reported if, on any day during the year the account balances (in aggregate, not each individual account) exceeds $10,000 (it should be noted, that since David has multiple accounts, the $10,000 limit is an aggregate total amongst all accounts and does not require $10,000 specifically in any one account.
The failure to properly file an FBAR may result in significant fines and penalties which you can learn about by reading here.
Beyond the FBAR, there is also a new requirement in which individuals have to report specified foreign assets on a form 8938. While real estate itself does not need to be reported, if the real estate is being held in a foreign corporation than the ownership value of the foreign corporation must be reported as well if it exceeds any one of the minimum threshold requirements, which varies based on country of residence and marital status. You can read more about FATCA Form 8938 here.
IRS Fines & Penalties
The IRS likes to issue penalties on matters involving international tax, reporting, and income. If you have failed to properly report your income from rental properties abroad, and/or foreign accounts or business ownership involving real estate, you may be subject to exceedingly high fines and penalties.
One of the best methods for avoiding these penalties or limiting/reducing them is through IRS Offshore Voluntary Disclosure.
IRS Offshore Voluntary Disclosure
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
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