IRS Reports on Non-Residents with U.S. Rental Property | KPMG | CA

IRS Reports on Non-Residents with U.S. Rental Property

IRS Reports on Non-Residents with U.S. Rental Property

A new U.S. Treasury report examines non-residents with U.S. rental properties.

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In its report, the IRS is outlining tax non-compliance for non-residents, and the IRS will be taking a closer look at Canadian residents who should be paying U.S. tax on rental income derived from U.S. real property. It may go so far as to take additional action to actively find non-compliant taxpayers. A recent report by the U.S. Treasury Inspector says that many non-residents are either not reporting their rental income in the United States, or are reporting income on a net basis (instead of a gross basis) without filing an election statement that is required to be made in this situation. The report recommends that the IRS undertake a compliance initiative to target foreign property owners who do not report, or do not properly report, rental income generated in the United States. To assist in identifying non-compliant taxpayers, the report recommends that the IRS consider obtaining property tax address lists through information-sharing partnerships with U.S. states.

As the IRS has agreed with the report's recommendations to increase its scrutiny in this area, Canadian residents who own rental property in the United States and who have not been compliant in the past may wish to consider taking steps now to ensure they are meeting their reporting obligations.

Legislative background
Generally, Canadian residents and other non-resident aliens (i.e., not U.S. citizens or nationals) are subject to U.S. income tax on any U.S. source income, which includes rental income from U.S. residential real property. As a result, these taxpayers are subject to a 30% U.S. income tax on U.S.-source rents that are not effectively connected with a U.S. trade or business, with no deductions available for related expenses such as depreciation, real estate taxes, mortgage interest, and maintenance. Where such rental income is effectively connected with a U.S. trade or business, it will be subject to tax at regular U.S. tax rates, after allowable deductions.

However, by making a "net election" under section 871(d) of the U.S. Tax Code, individuals with income that is not effectively connected to a U.S. trade or business may claim deductions for depreciation, mortgage interest, and other related expenses to offset U.S.-source rental income. In addition, this income will be taxed at graduated rates as opposed to the 30% flat rate.

Report recommendations
The report recommended that the IRS:

  • Develop a compliance initiative addressing non-U.S. owners who do not report rental income from real property they own in the United States.
  • Revise Form 1040NR, "U.S. Nonresident Alien Income Tax Return", to make it easier for taxpayers to make a net election.
  • Verify withholding credits claimed on Form 1040NR against information in the Foreign Investment in Real Property Tax Act (FIRPTA) database and research the non-resident's Master File account to determine if the U.S. property was rented and depreciated and to verify the calculation of the property's cost basis when it is sold.

The report also suggests that the IRS should explore the feasibility of obtaining property tax address lists through its information sharing partnerships with the U.S. states.

Although the IRS did not agree to the recommendation to verify withholding credits as its systems were currently unable to handle these requests, it accepted the Treasury report's other recommendations. In particular, the IRS says in its response that it will implement a compliance strategy by October 15, 2018. The IRS did not elaborate on the details of this new initiative.

The Treasury report [PDF 1.23 MB] is available to read online.

For more information, contact your KPMG adviser.

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