By Lynn M. Eller, CPA, APCIT, PFS and Miriam Song, J.D, LLM
It’s the season for peppermint lattes and holiday lights, but many of us are thinking back to vacations we took during the summer. Maybe you stayed at an Airbnb in Paris or a VRBO in Saint Thomas. You may have thought to yourself, what would it take to operate a foreign rental? It could be rented now then later become a second home for retirement. While becoming a landlord in a foreign country will have its own responsibilities, here’s a guide on some things to consider for income tax filings.
First, it is important to inform your tax advisor if you own the property in your name or through a legal entity. Many countries require nonresidents to own property through legal entities such as corporations or trusts. If this is the case, you may be required to file a Form 5471 or 3520. If you elect to treat the foreign entity as a pass-through, you may be required to complete the foreign disregarded entity Form 8858 or if owned with another person the foreign partnership Form 8865. You will want to do everything you can to avoid IRS penalties for missed or incorrect international forms.
Second, be ready to file taxes overseas. Most countries require income sourced in that country (which usually includes income from rental real estate) to be reported on tax returns, even if someone is a nonresident of that country, and even if the property shows a net loss. It is advisable to find a local accountant who understands the rules and is able to respond to any letters that you may receive from the foreign agencies.
Third, be sure to start keeping books and records for the residential rental. You should document how many days the property was used personally versus rented. The rental income can be tracked by a property manager or you can keep records yourself through separate bank statements. You will be able to deduct expenses similar to a rental in the U.S: advertising, cleaning and maintenance, legal and professional fees, mortgage interest, repairs, real estate taxes, insurance, management fees, and utilities. For all expenses, be sure to keep receipts and documentation. Another common expense deduction is depreciation, which is the cost of the asset (the building, or any other assets) taken as an expense over a number of years. For foreign residential rentals, the cost of the building is expensed on the Alternative Depreciation System over 30 years.
Finally, your foreign activities may produce other reporting obligations. You may need a foreign bank account to handle overseas affairs. If the aggregate value in your foreign bank accounts exceeds $10,000 at any time during the year, you will need to report the account and its highest value on FinCEN Form 114. The penalty for non-willful failure to file this form is currently $10,000.
You might also think about filing your U.S. tax return after your foreign tax return, because this will ensure that you are correctly capturing your worldwide income, which is required for those who file Forms 1040. It will also facilitate you taking the foreign tax credit, if you pay any foreign income taxes on your rental property.
Operating a foreign residential rental can be daunting, but we are here to help simplify this exciting adventure.