The U.S. Treasury Inspector General for Tax Administration (TIGTA) issued three reports over the past decade, highlighting the growing concern of noncompliance when it comes to nonresident aliens (NRAs) renting and selling U.S. real property.
The first report by the TIGTA, published in 2014, highlighted the IRS’ negligence to identify transactions by NRAs that are subject to the law and the agency’s negligence to pursue noncompliant individuals in accordance with the law. The second TIGTA report, issued in 2017, gave insight into the lack of U.S. tax compliance by NRAs holding U.S. rental property. The final TIGTA report, issued in 2020, takes an in-depth look at the IRS, calling out process and procedure negligence and a desperate need for change and accountability.
In response, the IRS made several updates, ramping up its processes and procedures in an attempt to rectify compliance filings, and also announced a “Compliance Campaign” in March 2020. The following information details compliance processes for the rental and sale of U.S. property held by an NRA and proactive options to become compliant with the IRS.
Sale Transaction of U.S. Real Property by NRAs
When a transaction occurs involving the sale of U.S. real property, there are responsibilities that both the buyer and the seller must fulfill to be compliant with the IRS if the seller is an NRA for U.S. income tax purposes.
It is the responsibility of the settlement agent (a title company, attorney, or buyer) to file Form 1099-S and identify if the seller is an NRA. If the seller is an NRA, the buyer is then responsible for filing Form 8288, U.S Withholding Tax Return for Certain Dispositions by Foreign Persons, and Form 8288-A, Statement of Withholding on Certain Dispositions by Foreign Persons. Buyers must complete and file Form 8288, enclosing Form 8288-A, within 20 days of the transfer of the relevant property and remit taxes withheld.
It is the NRA’s responsibility as the seller to file a timely Form 1040NR, U.S. Nonresident Alien Income Tax Return, with an attached copy of the Form 8288-A, stamped/approved by the IRS. This will allow NRAs to claim (if applicable) their income tax credits for the amounts withheld by the U.S. withholding agent and remitted to the IRS.
A buyer or foreign seller can apply for a Withholding Certificate by filing Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests. This allows for a complete exemption from, or reduction of, tax withholding (Section 1445(b)(4); Reg. 1.1445-3(a)). If Form 8288-B is filed timely and an exemption is allowed, the buyer does not need to file Form 8288. However, if Form 8288-B is filed after the transfer or if approved for a reduced amount of tax withholding, the buyer must file Form 8288 and attach the Withholding Certificate.
Proactive Options for NRA Taxpayers With U.S. Property Sales Issues in Prior Years
NRAs who filed Form 1040NR claiming inconsistent credits related to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) should file a qualified amended tax return Form 1040-X, Amended U.S. Individual Income Tax Return. To be a qualified amended return, an NRA should file Form 1040-X before any contact by the IRS or formal investigation is made.
NRAs who failed to file Forms 1040NR have the option to participate in the updated voluntary disclosure practice (UVDP) if their negligence to file was willingly or fraudulent. This provides taxpayers with a way to come into compliance with the law and could prevent criminal prosecution, which will still involve severe penalties.
For NRAs who failed to file Forms 1040NR and have no risk of criminality, there is now an option to make “quiet disclosures.” To do this, the NRA would file all Forms 1040NR and pay all corresponding taxes and interest charges. In the past, the IRS disapproved of such practice but has announced encouragement for quiet disclosures with the new compliance campaign in hopes of boosting NRAs compliance.
Rental Transactions of U.S. Real Property Held by NRAs
NRAs receiving passive income from U.S. sources, not connected with U.S. trade or business, are subject to a 30% income tax rate on gross income. This puts a responsibility on the withholding agent (renter, lessee, or property manager) to reserve 30% of the rents paid and send it to the IRS.
The more favorable approach is for the NRA to make the election under §871(d), allowing the rental to be treated as an active trade or business for U.S. tax purposes. The NRA will then be able to claim both rental expenses and depreciation as deductions from gross rental income, thereby significantly reducing the U.S. tax liability, as net rental income (versus gross rental income) is taxable. Once election §871(d) is made in year one, it remains in effect for all later years unless the IRS gives the NRA permission to revoke it.
An NRA who makes the §871(d) election would then report the income and deductions on Schedule E as part of Form 1040NR. The election is made by filing the income tax return required under §6012, including a statement to the effect that the election is being made.
In addition to making the election, it also is the responsibility of the NRA to inform the withholding agent of their current tax stance by supplying the withholding agent with Form W-8ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States, which notifies the agent that the rental income should be exempt from the standard 30% withholding.
Proactive Options for NRA Taxpayers With Rental Income Issues in Prior Years
NRAs who filed Form 1040NR but made no proper §871(d) election, claiming net income treatment, have two options. The first option is to file Form 1040-X to make the §871(d) election retroactively without seeking advanced permission from the IRS any time before the expiration of the period prescribed by §6511(a) or 6511(c). These sections detail that a claim for refund or credit generally must be filed by the taxpayer within three years from the time the relevant tax return was filed or within two years from the time the relevant taxes were paid, whichever comes later.
If the NRA wants an explicit blessing from the IRS, or the period prescribed in §6511(a) or §6511(c) has passed, the NRA has a second option. The second option would be to seek a private letter ruling (PLR) from the IRS National Office pursuant to Reg. 301.9100-3. This is commonly known as getting “§9100 relief.” Provided the taxpayer can establish that they were acting reasonably and in good faith and granting the extension will not prejudice the interests of the U.S. government, an extension will be granted, and the NRA will file Form 1040-X with the proper election.
Penalties
Failure to file Form 1040NR or 1040NR with no elections could result in a failure to file (and/or) failure to pay penalty on unpaid taxes based on gross earnings. The Failure to File penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late and up to a maximum of 25%.
If both a Failure to Pay and Failure to File penalty are applied in the same month, the Failure to File penalty is reduced by the amount of the Failure to Pay penalty for that month, for a combined penalty of 5% for each month or part of a month that the return was late.
The penalty for Form 8288 can be up to $10,000 for willful failure to collect and pay the tax. If the buyer violates these duties, then the buyer of the property sold by an NRA becomes liable for the taxes on the transaction, as well as any penalties and interest.
Takeaways
NRAs selling or renting U.S. real property should stay compliant with FIRPTA laws and should be proactive if they fear noncompliance in previous years. Individuals involved with foreign owners of U.S. real property should remain up to date with their obligations and responsibilities. The IRS’ announcement of a Compliance Campaign implies that stricter enforcement of these laws may be well underway and it’s important to ensure you’re compliant with your individual tax filing obligations.
How Forvis Mazars Can Help
For assistance with tax return preparation for transactions that involve NRAs renting and selling U.S. real property, or consultation for prior years’ filings you believe to be noncompliant, please reach out to a member of the Global Mobility team at Forvis Mazars.
Our service approach is collaborative and will provide you with proactive professionals, objective insights, and tailored strategic approaches for addressing your specific reporting requirements, including helping you navigate Form 8288, Form 1040NR, Form 1040-X, proper §871(d) elections for beneficial tax treatment and IRS notice resolution.