Don’t Turn Away Those Foreign Dollars
by Brent Green, CPA
Over the past few years, being a property manager has become a little more interesting with the changes in the economy and the fall of home prices. The shift in home prices has made the U.S. a haven for foreign investors who purchase property and maximize their ROI with rental income. Due to falling prices, as well as the high-quality U.S. building codes and the prestige of owning property in the U.S, these investors are not going away anytime soon. According to a 2015 report by the National Association of Realtors®, international clients purchased an estimated $54.4 billion worth of residential property in 12 months ending March 2015, or 4 percent of the total value of all U.S. home sales for the period. 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.
HOW DO I DETERMINE 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: 1. The Green Card Test (examining if they have a Green Card or not) 2. The Substantial Presence Test (a formula based on the number of days the owner spends in the United States). 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% of gross rent withholding (“FIRPTA”). These considerations can also be applied to foreign partnerships, foreign corporations or trusts.
Once anyone starts collecting rental income for a foreign homeowner, they are 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% tax quarterly, 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. then it will be to 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” cautions Christopher Picciurro, CPA, MBA, PFS, ARA, Founder of Nonresident Tax Advisors, CPA.
RISK VS REWARD
Risk vs 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. 50 units each producing $10,000 in gross revenue a year:
*Potential penalties do not include interest at applicable rates
30% 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
TOTAL RISK - $217,500
Estimated annual management fee income at 10% of gross rent
NOTE: If convicted of a felony, the fine is no more than $10,000 and 5 years in prison
GETTING THE PROPER FORMS IS IMPORTANT
Withholding Agents are required to withhold 30% of rental income paid to foreign individuals, foreign partnerships or corporations, and “single-member LLCs” with non resident members, unless the following has 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% withholding requirement. Property managers should make it a common practice to require and collect these documents up front. Brent Green, Managing Partner of Nonresident Tax Advisors, CPA recommends a proactive approach, “It’s better to let the owner know that you will be following the IRS requirements from the start and should be able to direct the owner to a qualified professional that can help them complete the necessary forms”.
WHAT DOES THE FOREIGN HOMEOWNER EXPECT FROM THEIR PROPERTY MANGER
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 the foreign homeowner is not considered a U.S. resident for income tax purposes and does not have a Social Security Number he/she will not be able to file a Form 1040. It should be noted that Form 1042-S requires an ITIN provided by the foreign homeowner and should also include the 30% withholding payment information if applicable.
SUMMARY In summary it is important to have a good understanding of your foreign clients. With this understanding and some proper planning, nonresident investors can be some of your easiest owners to deal with. Compliance should always be a key roll in your organization and keeping up with the latest tax laws can be complex. Be sure to align yourself with a professional who is knowledgeable about nonresident taxation and does more than just “dabble” in the field. Providing your nonresident investor with some upfront information and direction can go a long way in developing and protecting the client relationship.
Nonresident Tax Advisors, CPA - A division of Integrated Financial Group
44444 Mound Road, Suite 100
Sterling Heights, MI 48314