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January 21, 2009 - Phil Hodgen

Writing off carrying costs — for nonresidents

This is something that comes up again and again. Nonresident owns raw land (just dirt, nothing on it). There are some costs incurred each year — property taxes for sure, maybe mortgage interest, maybe a couple of other things. But property tax mostly.

How can these costs get converted into a tax deduction? Answer: not possible.

In order to get a tax deduction under U.S. law, there has to be a specific provision that allows the deduction.

Nonresidents are taxed in one of two ways —

  • On passive income received from U.S. sources, at 30% of gross income received. No deductions allowed.
  • On income attributed to a U.S. business activity. Deductions allowed.

If the income stream falls into one of those two categories, the U.S. can tax the nonresident. Otherwise, the nonresident escapes the clutches of the U.S. Treasury.

How does this apply to deductions?

Well, the only way deductions are even allowable is if they are attributed to a business activity conducted in the United States. First things first: passively holding U.S. real estate and not collecting any rent is not a business activity. Since the nonresident owner of vacant land isn’t active in a business, there is no activity on which to claim a deductible expense.

There is an election that a nonresident can make. This is called the “net election” and I have blogged about it before. This is where the nonresident real estate investor declares an election to have his/her U.S. real estate investment activity treated as if it is the conduct of an active business in the United States.

The election won’t help you, though.

The election successfully allows you to treat the ownership of that vacant land as a business activity in the United States. But the general rules of taxation, once you’re there, will only allow you to take deductions that are related to income derived from the business activity of owning real estate. Sitting on a land investment doesn’t generate income, therefore the associated expenses are not deductible. You can only take deductions in the year you generate income from that land.

Summary for those who just want to Cut To The Chase:

  • Nonresidents can’t deduct their carrying costs on raw land investments in the United States, whether they make the net election or not.
  • That is because in order to take deductions you have to have actual income from the land investment.
  • If you can generate some income from the land (rent it for grazing, parking cars, whatever), then you can take deductions.

Standard disclaimer: I am not your lawyer, this is not tax advice to you, go hire someone who can help you, kids don’t try this at home, wear sunscreen outside, and always carry a hankerchief.

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