One recurring concern our clients have is the status of the real estate they may hold overseas—whether a family home or a rental property is — What are the implications of holding foreign real estate, especially if you need to participate in the Offshore Voluntary Disclosure Program? This article will address the most common concerns and describe the action taxpayers should take.
Whether or not your foreign real estate produces income makes all the difference
The Tax Implications of Real Estate
For the most part, real estate is the same no matter where it’s located. The IRS has a hub for information about real estate: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Real-Estate-Tax-Center. This includes income, possible deductions, etc. However, things change dramatically when there has been unreported income, and then even more so when the property producing the income is located overseas.
Noncommercial Real Property
Many of our clients are concerned about potential consequences relating to their noncommercial real property overseas. The good news is that for the most part, there are no tax consequences associated with the property, except potential deductions or other beneficial tax treatments. This means that merely holding property overseas is not a problem.
We are often asked whether, when our clients are reporting their foreign assets on FBAR Form TDF 90-22.1, there is any way to report such property. The answer is no, there is no obligation to report real property on your FBARs (however, there is a new obligation since 2011 to file foreign assets on FATCA Form 8938).
There is one mysterious provision mentioned on the OVDP FAQ about non-rental property. It states that in the case of a property that “produces no income and there were no reporting requirements regarding this property”:
"…if offshore assets were acquired with funds that were subject to U.S. tax but on which no such tax was paid, the offshore penalty would apply regardless of whether the assets are producing current income. Assuming that the assets were acquired with after-tax funds or from funds that were not subject to U.S. taxation, if the assets have not yet produced any income, there has been no U.S. taxable event and no reporting obligation to disclose."
What does this mean?
Essentially, that if the property has been used as a tax haven/tax evasion device specifically, then it is subject to the offshore penalty. However, the offshore penalty is never intended to apply to the same funds multiple times, so if that amount is already “captured” by the bank accounts which were used to purchase the property, it will still be excluded from the penalty calculation to prevent double-counting.
Unreported Foreign Real Estate Income
Generally, this income takes the form of rent, although it is possible to realize capital gains on sales of foreign real estate as well. If you have unreported foreign income of any kind, you are a great candidate for the Offshore Voluntary Disclosure Program.
One major point with regard to income-producing foreign real estate is that according to the OVDP FAQ, the fair market value of the real estate should be included in the penalty base if the property was associated with tax noncompliance. Usually, the standard OVDP penalty applies to the year with the maximum balance, including all bank accounts and income-producing property. Often in such cases, opting out of the standard penalty structure and having an examiner determine the appropriate penalty is a client’s best interest.
To learn more about information returns associated with foreign accounts and assets, click on the box below.
