US Tax of Usufruct & Naked Ownership: FBAR & FATCA
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US Taxation of a Usufruct
US Taxation of Usufruct & Naked Ownership: Unless you live in Louisiana, or are familiar with civil law, you may be unfamiliar with the concept of a usufruct and naked ownership. In many European countries, as well as in Louisiana, there is a form of ownership called “Usufruct.”
This type of ownership is different than the general type of asset ownership available in the U.S. It is a hybrid of estate law, trust and general ownership/borrowing concepts.
What make these types of structures even more complicated, is the reporting under IRS International Information return filing – such as FBAR & FATCA.
Naked Ownership & Usufruct
Naked ownership is the concept of owning the property like a shell – without certain rights. Generally, when someone has naked ownership of a property, they own it but they do not have full rights to the property. Rather, another person has the limited right to use and enjoy the property.
In a common situation, a client will have received a gift or inheritance of a property or business.
The business may generate income, but that income is all going to a 3rd party, aka the Usufruct.
Usufruct Example
Michael is 9 years old when his father purchases him a property in an up-and-coming area that has a tenant/owner.
Michael’s Father believes the value will shoot-up in the future, and wants to take advantage of the ownership now. Michael’s family does not need the income, so the immediate income and earnings is not important.
Therefore, they purchase naked ownership of the home.
- The Usufruct is the tenant and owns the Usufructuary
- Michael is the Naked Owner
Rights of the Usufruct
The Usufruct has limited rights to the property.
This is generally similar to someone with a life estate, including residing in the property and/or collecting rent.
It also resembles a QPRT to the extent that it allows someone to reside in the home (such as a parent), without giving them the right to sell the property or make an major changes to it.
U.S. Tax of a Usufruct
Generally, a Naked Owner of the property is not going to be taxed on the income.
Why?
Because the naked owner does not have any rights to the income.
It is similar to owning an asset as a secondary owner with no right to income. While it may be reportable (FBAR & FATCA), if there is no income attributed to the naked owner, then there is no tax.
As to the Usufruct, they would be taxed. Even if the Usufruct cannot sell the property, they are enjoying the income and therefore would pay tax on it.
Reporting for Naked Ownership & Usufruct
A Naked Owner would presumably have to report the asset and possibly for the Usufruct.
Why?
An income stream is not required for someone to have to report the assets, so therefore the naked owner would have a reporting requirement. In other words, assets are reportable even if there is no income attributed to it.
As to the Usufruct, since they are receiving the income, the IRS may take the position that the Usufruct is a constructive owner. Since offshore penalties for non-compliance can be very comprehensive, compliance is crucial.
Here are some common reporting examples:
FBAR (FinCEN Form 114)
Reporting Foreign Bank Accounts
FATCA Form 8938
Reporting Foreign Assets
PFIC Form 8621
Reporting Investment Funds
Form 3520
Reporting Gifts and Trust
Form 3520-A
Reporting Trust Ownership
Form 5471
Reporting Foreign Corporations
Form 8865
Reporting Foreign Partnerships
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