How Do Taxes Apply to Rental Property Owned by Nonresident Aliens?

 Posted on November 12, 2020 in Taxation Law

The U.S. Tax Code is very complex, and taxpayers will often struggle to understand their tax obligations, their requirements for filing tax returns and other forms, and the steps they should take to avoid penalties. Nonresident aliens (NRAs), or those who are not U.S. citizens or U.S. nationals and do not maintain a substantial presence in the United States, may have certain tax obligations, including the requirement to pay taxes on income generated by rental properties. Failure to file the proper forms and pay taxes on this income may result in tax audits and penalties.

Tax Requirements for Rental Income From Real Property

When an NRA acquires real property in the United States, that person will usually not be required to file any forms with the IRS or pay taxes. However, there will be tax on any income earned through the rental of this property. The tax rate that applies to this income will depend on whether it is considered passive income (known as FDAP income) or effectively connected income (ECI) that is associated with a U.S. trade or business.

FDAP income is generally taxed at a rate of 30% of the gross amount of income earned by a rental property. These taxes will usually be withheld by a withholding agent (such as a property manager, renter, or lessee) who will send this amount to the IRS. ECI, on the other hand, is subject to graduated tax rates, and taxes apply to net income earned after deductions and expenses.

Even if a rental property is not associated with a U.S. trade or business, a property owner can make an election under Section 871(d) of the Internal Revenue Code to treat income from the property as ECI. This can be done by attaching a statement to the NRA’s tax return that specifies that this choice is being made. The statement should also list all of an NRA’s interests in real property in the United States, specify the location of the property in question and the dates it was owned, describe any improvements made to the property, and detail the income earned from the property. This election will remain in effect in subsequent tax years unless it is revoked by the taxpayer.

An NRA must file a tax return (Form 1040NR) for each year he or she earns ECI from a rental property. Failure to submit a timely tax return will result in the 30% tax rate being applied to the gross income earned by the property, without the ability to claim any deductions or credits.

Contact Our San Jose Nonresident Alien Tax Lawyer

If you are a nonresident alien who earns income from a rental property, or if you are facing an IRS audit related to rental income, John D. Teter Law Offices can help you determine the most beneficial way to report this income, meet your tax obligations, and avoid penalties. Contact our San Jose, CA tax law attorney today at 408-866-1810.

Sources:

https://www.irs.gov/individuals/international-taxpayers/nonresident-aliens-real-property-located-in-the-us