I specialize in international taxation from San Diego, California. I do consultation, tax planning, and tax compliance for nonresidents who own or are planning on buying a house in the United States. Today, I want to explain why it is beneficial for a nonresident owner of U.S. real estate to file a tax return.
Foreign (nonresident) real estate owners can choose to pay federal income tax on their rental income in one of two ways:
General rule
Gross income from real property located in the United States that is owned by a nonresident alien is taxed at a 30% (or lower treaty) rate. The gross income cannot be reduced by any expense.
Example of General Rule.
Gross Rental Income: $10,000
Operating expenses: ($1,000)
Depreciation: ($4,000)
Property Tax: ($3,000)
Total Expenses ($8,000) – DISALLOWED
Taxable Income: $10,000
Total Income Tax: $3,000 ($10,000 x 30%)
Special Election
Nonresident owner can choose to treat real estate income as income effectively connected with a trade or business in the United States. The choice applies to all income from real property located in the United States. If a nonresident makes this election, they can claim deductions, attributable to the real property income and only the net income from real property is taxed.
Example of Special Election.
Gross Rental Income: $10,000
Operating expenses: ($1,000)
Depreciation: ($4,000)
Property Tax: ($3,000)
Total Expenses ($8,000)
Taxable Income: $2,000
Total Income Tax: $200 ($2,000 x 10%)
It is obvious that “special election” gives the best result.
Here is the problem, a U.S. person (a tenant or a management company) paying income to a nonresident landlord must withhold 30% tax on such payment. For example, if they owe a nonresident landlord $10,000, the hold back $3,000 and send it to IRS. They also send to the landlord Form 1042-S showing that they properly withheld tax from the rental income. So, if the nonresident landlord tax liability is satisfied by the withholding of tax then he or she does not have to file a U.S. tax return (Form 1040NR). But if a nonresident landlord wants a better “net income” tax treatment, they must file a tax return with “special election”.
Example: file a tax return after tenant`s withholding
Gross Rental Income: $10,000
Tax Withholding (30%): ($3,000)
Cash to the landlord: $7,000
Step 2. File a tax return and claim deductions:
Gross Rental Income: $10,000
Operating expenses: ($1,000)
Depreciation: ($4,000)
Property Tax: ($3,000)
Total Expenses: ($8,000)
Taxable Income: $2,000
Total Income Tax (10%): $200 ($2,000 x 10%)
Tax Paid (Form 1042-S): $3,000
REFUND from IRS: $2,800
If a landlord wants additional cash in their pocket, they must file a tax return to claim the “special election”.
If someone you know needs help with a tax return, an ITIN, CAA service, a withholding refund, or any other international tax issues, please feel free to contact us directly at (760) 842-7885 or by email at info@usibts.com
U.S. International Business Tax Solutions
3520 College Blvd., Suite 204,
Oceanside, CA, USA 92056
Tel: +1-760-842-7885
Fax: +1-760-683-2208
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