U.S. Tax Issues When Forming a Foreign Real Estate Entity

U.S. Tax Issues When Choosing a Foreign Entity for Real Estate

U.S. Tax Issues When Picking a Foreign Entity for Real Estate

When a taxpayer is a U.S. person for tax purposes, they may have several international information reporting requirements to disclose their foreign assets, accounts, and investments on a U.S. tax return. While a foreign rental property typically does not have a Form 8938 (FATCA) or FBAR reporting requirement, the owner may have to file a Form 5471 if they own a foreign corporation. As we have written about previously, in many foreign countries it is common to place assets into an entity such as a corporation – with one common example being the Sociedad Anonima in countries such as Argentina and Portugal. For the unsuspecting taxpayer, owning a foreign property in a foreign entity such as a Sociedad Anonima can take an asset category that does not typically have to be reported (foreign real estate) and now requires it to be disclosed on one of the most comprehensive international information reporting forms (Form 5471). Let’s look at a few key U.S. tax issues when purchasing property in a foreign entity.

U.S. Tax vs Reporting

The first factor to consider is the distinction between U.S. tax and U.S. reporting. The ownership of a foreign real estate property, even if it is in a foreign entity is not necessarily taxable unless income is generated or the asset is sold.

Is it a Primary Residence?

if the asset is a primary residence, then it is important to determine how the asset is going to be structured for ownership purposes to ensure the taxpayer may obtain the $250K/$500K primary residence exclusion.

Is it an Income Producing Property?

If the asset is an income-generating property, it begins to get more complicated because the taxpayer may be paying taxes through the foreign entity instead of as an individual impaired by doing so, which will impact how the taxpayer may be able to take deductions in the United States on their tax return and whether issues such as GILTI may apply.

Is it a CFC?

A CFC is a controlled foreign corporation which means that U.S. person shareholders each own more than 50% (attribution rules apply). If the entity is not owned more than 50% by U.S. persons then it is not a controlled foreign corporation — and issues such as GILTI, Subpart F may nit apply. But if it is a controlled foreign corporation, then taxpayers should assess the entity selection carefully due to the tax implications and reporting headaches of having a CFC.

Is it PFIC (PFIC/CFC Crossover)?

Even if the asset is not considered a controlled foreign corporation comma it may be considered a Passive Foreign Investment Company — depending on which assets are passive and which assets generate income and the type of income generated (passive or active).

Are Taxes Paid Overseas?

The Taxpayer may be able to claim foreign tax credits on income generated from the property. Whether the foreign income tax is paid by the individual or by the entity will determine how the foreign tax credits may be claimed in the United States.

Per Se vs Non-Per Se Corporations

Another very important consideration is to determine whether or not the specific entity type may be disregarded. If the entity cannot be disregarded, the taxpayer has to go through the hassle of filing Form 5471 and all of the additional reporting requirements. The following is a list of the per se corporations (that cannot be disregarded for U.S. tax purposes).

Disregarding the Entity (Non-Income Producing)

If the property within the entity is not income-producing then there may not be any negative tax implications for disregarding the entity — and it can simplify the annual reporting requirements. This is especially true in situations in which the property is simply a primary or secondary residence that’s not used to generate income.

Disregarding the Entity (Income Producing)

If the property is income-producing, then there are more considerations such as whether it is a controlled foreign corporation, whether the income qualifies as GILTI or Subpart F, and whether the taxpayer has paid any foreign taxes on the income in the foreign country where the entity is located. Ideally, taxpayers should conduct a U.S. tax analysis before they form an entity, but that is not always feasible. Whether the property is owned individually or by an entity will also impact the application of the primary residence exclusion rule if the property is being used as a primary residence.

Revenue Procedure 92-70

If the taxpayer cannot disregard the entity, they may consider reporting the entity as a dormant corporation. The requirements can be found under Revenue Procedure 92-70. Unfortunately, due to the global surge in real estate prices, it may be difficult for the taxpayer to qualify as a dormant corporation.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.