US IRS launches compliance campaign for non-resident property owners

Thursday, 15 October 2020
The US Internal Revenue Service's (IRS’) Large Business and International Division has launched a further audit campaign, aimed at non-resident foreigners who have not disclosed or paid withholding tax on their income from real property in the US as required by the Foreign Investment in Real Property Tax Act 1980 (FIRPTA).
US property tax

Before the enactment of FIRPTA, it was possible for a foreign investor to structure an investment in US real estate without paying federal income tax on it. FIRPTA now taxes foreign persons on the disposition of their US real property interests, and imposes federal tax obligations on foreign investors that are similar to those imposed on US persons. Generally, the buyer or transferee is the withholding agent and is required to withhold 15 per cent of the amount realised on the sale, file the required forms, and remit the tax to IRS.

However, the 15 per cent withheld tax has no correlation to the actual amount of US tax due on the sale of the property. It simply ensures that US tax will be collected and incentivises owners to file appropriate tax returns and claim a credit for the withheld funds. If the 15 per cent withheld tax exceeds the maximum tax liability, the seller can apply for a withholding certificate to reduce the withholding to the maximum amount of tax due.

There is a further exemption where the purchase price is not more than USD300,000 and the purchaser intends to reside in the property for at least 50 per cent of the time for the first 24 months following purchase.

The new IRS campaign is intended to increase compliance with the complex US tax rules relating to real property transactions, through 'targeted, issue-based examinations, education and guidance', says legal services firm Holland and Knight. The IRS hopes to improve its choice of returns to audit through identifying issues representing a risk of non-compliance.

Currently, there are nearly 60 IRS campaigns, several of which relate to high-net-worth individuals cross-border issues. Another campaign launched this month targets non-resident aliens who do not properly report rental income from US real property. Non-residents who are not in a US rental business are subject to a 30 per cent US withholding tax imposed on the gross amount of the rents received, unless they make a so-called 'net election' to treat the rental income as effectively connected with the conduct of a US trade or business. Doing so enables the non-resident to write off costs against the gross rental income, in which case the net income would be subject to US tax at ordinary income tax rates.

Foreign property owners are an obvious target for these audit campaigns, according to Holland and Knight, because purchase of US real estate by foreign nationals is a major source of investment in the US. Property sales to foreign buyers totalled USD78 billion in 2019.


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