Don't turn away those foreign dollars.
For property managers, this can be a complex opportunity. There are a few things to consider when taking on a foreign investor. The financial benefits are obvious, but you need to consider what your risks could be. With some understanding of the U.S. tax compliance requirements and a well structured intake process, you can remove yourself from these risks altogether.
DEFINE A U.S. NONRESIDENT
One of the first things to consider is, "How do I define a U.S. nonresident owner for tax purposes?" In most cases, the answer is quite clear. The individual is a citizen of another country, they visit infrequently and simply own property in the U.S. When it is unclear whether the individual in question is considered a resident or nonresident of the U.S. for income tax purposes, there are two basic tests: First, The Green Card Test (examining if they have a Green Card or not); Second, The Substantial Presence Test (a formula based on the number of days the owner spends in the U.S.). Be aware of "the domestic single-member LLC myth." Many property managers make the mistake of assuming that a domestic single-member LLC is held to domestic tax standards. In fact, if the member is a nonresident of the U.S., the property income that individual has is subject to a different standard, possibly including the mandatory 30 percent of gross rent withholding ("FIRPTA"). These considerations can also be applied to foreign partnerships, foreign corporations or trusts.
Any person or company who collects rent on behalf of a foreign homeowner is considered a "Withholding Agent" by the IRS. Withholding Agent status was created from the Foreign Investment in Real Property Act of 1980 ("FIRPTA"). The basic principle of FIRPTA, when it was introduced, was the concept of mandatory income tax withholding. FIRPTA puts the onus on those who have control of the funds derived from certain types of income, referring to those individuals or companies as Withholding Agents. A Withholding Agent is defined as Any U.S. or foreign person that has control, receipt, custody, disposal or payment of any item of income of a foreign person that is subject to withholding. As a Withholding Agent, you are personally liable for any tax required to be withheld, independent of the tax liability of the foreign person to whom the payment is made. If the withholding agent fails to withhold, submit the 30 percent tax as required and the foreign payee fails to satisfy their U.S. tax liability, both parties are liable for the tax and any related penalties and interest. Basically, the IRS is going to find it much easier to collect income tax from the Withholding Agent in the U.S. than chase down a foreign individual in another country. To add more risk to the matter, property managers (or any Withholding Agents) do not have any defense in this situation--it is cut and dry. The risk of property managers ignoring these important IRS requirements far outweighs any benefits.
GETTING THE PROPER FORMS IS IMPORTANT
Withholding Agents are required to withhold 30 percent of rental income paid to foreign individuals, foreign partnerships or corporations, and single-member LLCs with nonresident members, unless the following two things have been received by the Withholding Agent: 1. W-8 series form with proper tax election verbiage; 2. Individual Tax Identification Number ("ITIN") or EIN, depending on the ownership structure. With the proper documentation from your foreign homeowner, you can avoid the 30 percent withholding requirement. Property managers should make it a common practice to require and collect these documents upfront. It's better to let the owner know that you will be following the IRS requirements from the start so that you can direct the owner to a qualified professional that can help them complete the necessary forms.
WHAT DOES THE FOREIGN HOMEOWNER EXPECT FROM THEIR PROPERTY MANAGER?
As required by the IRS, a typical domestic homeowner receives end-of-year tax statements, as does a foreign homeowner. Each classification of owners requires different forms; this is where property managers can make a costly mistake. Depending on the type of entity, the IRS requires that a property manager provides their domestic homeowners a copy of Form 1099 annually with the other copy being sent to the IRS. For foreign homeowners, a property manager must send a Form 1042-S instead. Because the IRS receives a copy of the 1099, they will be looking for a Form 1040 to match the Social Security Number and the amount reported as income on the 1099. Since foreign homeowners are not considered U.S. residents for income tax purposes, they will not be able to file a Form 1040. Rather, the correct income tax form would be a 1040NR and it should be noted that Form 1042-S requires an ITIN provided by the foreign homeowner.
RISK VERSUS REWARD
Case study of a property manager who has a foreign client with 50 units under management and no ITIN and W8-ECI on file:
Potential Property Manager's Penalty: 50 units each producing $10,000 in gross revenue a year: Potential penalties do not include interest at applicable rates PENALTY: 30 percent of gross rental withholding penalty $150,000 Failure to deposit taxes within 15 days $15,000 Failure to file Form 1042-S $15,000 Late filing penalty of Form 1042 $37,500 Risk Total $217,500 Estimated annual management fee income at 10 percent of gross rent Note: If convicted of felony, the fine is no more than $10,000 and five years in prison
BRENT GREEN, CPA, (INFO@INTEGRATEDFG.COM) IS MANAGING PARTNER & INTERNATIONAL TAX CONSULTANT AT NONRESIDENT TAX ADVISORS, A DIVISION OF INTEGRATED FINANCIAL GROUP, IN STERLING HEIGHTS, MICH.
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|Title Annotation:||Spotlight/Global Practices; foreign investment on property|
|Comment:||Don't turn away those foreign dollars.(Spotlight/Global Practices)(foreign investment on property)|
|Publication:||Journal of Property Management|
|Date:||Sep 1, 2014|
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