Tax Rules for Holding Real Estate

Tax Rules for Nonresident Aliens Holding Real Estate

Income from the rental of real property is generally considered income that is not effectively connected with a U.S. trade or business. As non-effectively connected income, it is taxed at a flat rate of 30% of gross (absent a treaty provision) and no deductions are allowed. You are not required to file a U.S. income tax return if the payor withholds a tax of 30%, and you have no other income to report.

Rental Real Estate Election

You might be thinking that a 30% tax on gross rental income sounds like a lousy deal, and it is. Fortunately, an election is available under IRC Sec. 871(d) to have the net income (after expenses) taxed as income effectively connected with a U.S. trade or business. This is generally a much better option for nonresident aliens with LLCs, as any net income is taxed at graduated rates beginning at 10%.

If you decide to make this election, you are exempt from the tax withholding requirement (Reg. Sec. 1.1441-4(a)). Your income and deductions relating to the rental of real property are reported on Schedule E, which is included with your federal Form 1040NR. If you are a partner in a partnership, the election is made at the individual level rather than by the partnership.

The Sale of Real Property

Gains and losses from the sale or exchange of US real property interests are taxed as if you are engaged in a trade or business in the United States (IRC Sec. 897). You must treat the gain or loss as effectively connected with a trade or business, regardless of how you use the property. The tax rate on net long-term capital gains ranges from 0-20%, depending on the amount of your total taxable income.

Generally, a federal tax withholding of 15% of the sales price is required from anyone who purchases real estate from a nonresident alien (IRC Sec. 1445). This withholding is claimed as a credit on your non-resident tax return. Form 8288-A (Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests), stamped as received by the IRS, must be attached to the return as evidence of the amount withheld.

Alternatively, Form 8288-B (Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests) can be filed with the IRS to obtain a withholding certificate to reduce or eliminate the withholding. This can be filed by the closing date to prevent the closing agent from sending the withheld tax to the IRS until after the IRS makes its determination, or after the closing date to request a refund from the IRS.