Investing in U.S. real estate is a great opportunity for foreign investors. However, many purchase the property, start renting it out and don’t file the necessary paperwork to protect their investment. You could end up paying withholding tax of 30% of gross rental income if you don’t make the appropriate elections and file the proper tax forms. Who wants to let the IRS hold on to their money for months until it is time to file your annual income tax return? Alternatively, if you follow a few simple procedures you could have the income taxed on the “net income basis.” This enables you to make estimated tax payments based on gross rental income less expenses at the rate of 35%.
For example, you purchase real estate in the U.S. for $85,000. You do not file any paperwork. Let’s say the annual rent is $13,200. The property manager would need to withhold 30% of the gross rental. This would be $3,960 that the property manager would remit to the IRS. You would not see any refund from this until you filed your annual nonresident income tax return.
Alternatively, let’s say you follow the steps below to be taxed on the “net income basis.”
Gross rental income $ 13,200
Less: Property management $ 1,320
Real estate taxes $ 1,600
Insurance $ 600
Net rental income $ 9,680
Less: Depreciation $ 2,400
Personal exemption $ 3,650
Taxable income $ 3,630
Required estimated tax payment $ 1,270 (35% of taxable income)
Actual tax liability upon filing nonresident income tax return:
Federal tax $ 363
Georgia tax $ 145
So in the first scenario you gave the IRS $3,452 of your money interest free for months. Alternatively, in the second scenario it was only $762 for difference of $2,690. As you can see this is just based on one small rental property, imagine how quickly this can add up.
Let’s take a step further and assume you have 10 of the above rental properties. If you do not file any paperwork the property manager is required to withhold $39,600. If you do file the proper paperwork you would be required to make estimated tax payments of $12,705. Actual tax liability would be $6,700.
We are not going to be able to help you avoid paying the tax but we will be able to help you minimize it so you have more of your money for your use throughout the year.
So now you ask what are the steps needed to do this and how complicated will it be? Not complicated at all!
First, you will need to apply for a taxpayer identification number, if you do not already have one.
Second, you will file a form W8ECI with the property manager certifying that your income is effectively connected with a trade or business (to be filed every 3rd year).
Third, you will need to file quarterly estimated tax payments to the IRS at 35% of your gross rental income less expenses. Finally, you will file your nonresident income tax return to claim any refund or remit any tax due on an annual basis.
I am not a CPA or an attorney and you should always check everything out with your legal advisors.
If you need a CPA in the USA that knows and understands the intricacies for nonresident investors; call me. I’d be happy to refer you to the competent CPAs our clients use.
(813) 435 – 1551 ext. 1010