Foreign Rental Real Estate Income & the IRS
How to Report Foreign Rental Real Estate Income to IRS: When a U.S. person has foreign property that generates rental income, it is reportable to the IRS. This is true, even if the deductions exceed the income, and/or if the income generates is below the threshold for reporting in the foreign country. The failure to report the real estate may result in fines and penalties. These can be exacerbated if there are also overseas accounts, assets, or investment to report.
Foreign Rental Income and U.S. Tax
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.
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.
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.
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.
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.
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.
Out of Compliance?
Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.
We Specialize in Streamlined & Offshore Voluntary Disclosure
Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure.
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