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Nonresident Options for Unreported Rental Income of U.S. Real Estate

Posted on 08/27/16

A nonresident renting U.S. real estate has two options as to how this activity will be taxed at the federal level.  Oftentimes, a nonresident does not become aware of these requirements until the year that the property is sold.  At that point, there is no good solution to becoming compliant.  While there are alternatives available, they each come with associated risks.

Nonresidents are required to pay a tax of 30% of the gross annual rental income to the Internal Revenue Service (IRS) each year.  It is the obligation of the nonresident or property manager to ensure that this payment is made.  No notification of tax due will be sent by the IRS.   If this is payment is made, filing a U.S. federal income tax return is not required, but this also means that no tax benefit for deduction of expenses is allowed.

In order to avoid the mandatory 30% withholding, the nonresident may elect to treat the rental activity as effectively connected with a U.S. trade or business. By doing so, the nonresident agrees to file annual U.S. income tax returns in lieu of paying the 30% tax on the gross rent.  Making this election is the most common choice.  It allows the related business expenses to be deducted against the rental income, oftentimes reducing the tax liability to zero.   If there is a property manager, the nonresident must provide him with a completed Form W-8ECI.  The property manager must keep this form on file to support why he is not withholding and remitting the 30% tax to the IRS.

If the nonresident has neither remitted the 30% tax nor filed annual income tax returns for any of the years that the property has been rented, there is no good solution to this situation.  There are four alternatives available, which are described below along with their associated risks:

  1. File U.S. income tax returns for all prior years that the property was rented, making the election to treat the rental activity as effectively connected with a U.S. trade or business.  The risk of filing late returns is that the IRS could disallow the deductions associated with making the election.  If this were to happen, they could then assess 30% tax on the gross rental income, plus related penalties and interest.
  2. Pay the 30% tax on the gross rental income for each year that the property was rented.  The IRS will assess penalties and interest for each year that the payment was made after the due date.
  3. File a current year income tax return to report the sale of the rental property and pay the 30% tax on the current year rental income.  Since no prior year income tax returns have been filed, nor has the 30% tax been paid for any of these years, all prior years remain open to potential assessment by the IRS of the 30% tax plus related penalties and interest.
  4. File a current year income tax return to report the sale of the rental property, making the election to treat the rental activity as effectively connected with a U.S. trade or business. Since no prior year income tax returns have been filed, nor has the 30% tax been paid for any of these years, all prior years remain open to potential assessment by the IRS of the 30% tax plus related penalties and interest.

It is up to the nonresident to take into account his particular circumstances and decide how to proceed.

If you have questions about your options or any of the associated issues, please contact Ann Harman at or 941-365-4617.

About the Author

Ann Harman

Kerkering, Barberio & Co.
1990 Main Street, Suite 801
Sarasota, FL 34236
(941) 365-4617
aharman@kbgrp.com

Ms Harman concentrates areas of practice in business and personal taxation, with an emphasis on inbound international clients and clients with International Tax considerations.

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