Is Foreign Rental Income Taxable and Reportable in the U.S.?

Foreign Rental Property Income and Depreciation (Examples)

Foreign Rental Property Income and Depreciation (Examples)

The United States taxes U.S. persons on their worldwide income. And many U.S. taxpayers who previously lived and worked in a foreign country may still own one or more properties in that country that are being rented while the taxpayer resides in the United States. The term ‘worldwide income’ refers to both earned and passive income and includes income generated from a foreign rental property, even when the Taxpayer no longer lives in that country — and even if the income is accumulated overseas and not repatriated to the U.S. Foreign rental property income reporting can be complicated because even if the property nets a loss after expenses, the property’s income is still reportable on a U.S. tax return, even if only to show the loss. Likewise, in some countries like the UK, if the income falls below a certain threshold, then the individual is not taxed on that rental property income, but unfortunately, that threshold does not apply to the U.S. tax system.

Foreign Rental Income is Taxable

The first thing the U.S. person should be aware of is that if they own rental property or foreign country and that foreign property generates income, then that income is reportable on a U.S. tax return. Even though land and property are typically considered ‘unique’ to the country it is located in, the U.S. taxes them on their worldwide income, so the income is still reportable on a U.S. tax return.

• • Example: Adam is a lawful permanent resident who has a property in a foreign country that he uses as a rental. The rental generates $50,000 of income each year and $15,000 worth of expenses. Adam is required to include this information on his tax return, Schedule E, even though the money remains in the foreign country and taxes were paid in the foreign country as well.

What About Rental Expenses?

Taxpayers who have foreign rental income can claim most of the same deductions that they would claim for a U.S. property. Typically, this is reported on IRS Form 1040 Schedule E. For example, the taxpayer had repairs on the property, commissions, cleaning and maintenance, etc., and these are all able to be deducted on a U.S. tax return. This may ultimately result in there being a net loss when the total of the deductions is compared to the gross income.

• • Example: Brenda is a U.S. visa holder who meets the substantial presence test and has a rental property in a foreign country. The property grosses $25,000 a year in income, but she also has expenses such as cleaning and maintenance, management fees, HOA fees, etc., which brings the net income down to $17,000 a year. Brenda will report both the gross income and the expenses on her Schedule E and not just the net income on her tax return.

What if the Expenses Exceed the Income?

Even if the expenses exceed the income, both the income and expenses are reportable on a U.S. tax return. The taxpayer may not end up owing any taxes on the income and may even be entitled to claim losses in the current year and future years, but from a baseline perspective, just because the expenses exceed the income does not mean the taxpayer is exempt from having to report the income and expenses on their U.S. tax return.

• • Example: Charlie has multiple rental properties in five different countries that generate $150,000 of income each year, and also about $180,000 of expenses. Even though the expenses exceed the income, Charlie must report both the income and the expenses for all the properties on his tax return.

Depreciation of Foreign Rental Property

In the United States, non-commercial property, such as a home that is being used for rent, is typically depreciated over 27.5 years (this can potentially change or be altered depending on the specific facts and circumstances), but typically, the structure of the property is depreciated over 27.5 years. For foreign rental property, the depreciation schedule is a bit longer, and it is 30 years instead of 27.5 years. Generally, commercial property is depreciated over 40 years instead of 30. *Even if the foreign country does not offer depreciation as an expense, typically the taxpayer can still claim depreciation on their U.S. tax return, noting that depreciation is limited to structures and improvements and does not include the land, and when it is time to sell the property, that depreciation is factored back in to the sale cost and expenses.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Late-Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.