Apartment security deposits and Form 8938

Consider a simple situation. An American living abroad rents an apartment. As is usual in these situations, the tenant gives the landlord a security deposit.The intrepid authors of Section 6038D and the Temporary Regulations under that Section could not possibly mean to force you to list the security deposit on Form 8938. Could they?Interestingly (for certain vanishingly small values of $INTERESTING), it requires a fair bit of analysis and a judgment call (using an English teacher's brain, not a tax lawyer's brain) in order to decide that the answer is "no."Form 8938 requires Americans abroad to tell the United States government about their "specified foreign financial assets." Thus, the technically accurate question to ask is whether the security deposit you put down for the apartment you live in is a "specified foreign financial asset".

Definition 1 - Specified Foreign Financial Asset

We start with the definition of "specified foreign financial asset" from Temp. Treas. Reg Section 1.6038D-3T.The first definition says:

Except as otherwise provided in this section, a specified foreign financial asset includes any financial account maintained by a foreign financial institution. Temp. Treas. Regs. Section 1.6038D-3T(a)(1).

A "foreign financial institution" is described in the preamble to the Temporary Regulations:

A foreign financial institution is defined by reference to section 1471(d)(4). For this purpose, a foreign financial institution is a financial institution (as determined under section 1471(d)(5)) that is a foreign entity (as determined under section 1473(5)). Under section 1471(d)(5), a financial institution is any entity that -- (1) Accepts deposits in the ordinary course of a banking or similar business; (2) Holds financial assets for the account of others as a substantial portion of its business; or (3) Is engaged, or holds itself out as being engaged, primarily in the business of investing, reinvesting, or trading in securities (as defined in section 475(c)(2) without regard to the last sentence thereof), partnership interests, commodities (as defined in section 475(e)(2)), or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities.

Self-evidently, a landlord is not a foreign financial institution. Therefore, your money sitting in the hands of a security deposit for an apartment rental cannot be a specified foreign financial asset under the first definition.

Definition 2 - Specified Foreign Financial Asset

But we have a problem. The first definition of "specified foreign financial asset" uses that deathless phrase found so often in tax law -- "Except as otherwise provided." And it uses an immensely useful weasel word -- the word "include".The second definition of specified foreign financial account helps us resolve the ambiguities built into the first definition. Temp. Treas. Regs. Section 1.6038D-3T(b)(1) says:

(b) Other specified foreign financial assets -- (1) In general. Except as otherwise provided in this section, a specified foreign financial asset includes any of the following assets that are held for investment and not held in an account maintained by a financial institution --

(i) Stock or securities issued by a person other than a United States person; (ii) A financial instrument or contract that has an issuer or counterparty which is other than a United States person; and (iii) An interest in a foreign entity.

There's that deathless "except as otherwise provided" language again -- that creates so many possibilities for giant mobius strips of never-resolving tax logic.But I digress.This definition says that if you have one of the three listed assets, and you hold it for investment, and it is not held in an account with a financial institution (hey! a landlord is not a financial institution!), then you have a "specified foreign financial asset" that must be reported on Form 8938.Let's look at the asset definitions.We are pretty sure that a security deposit can't be a stock or security. Knock (i) off the list.We are pretty sure that a security deposit is not an interest in a foreign entity. That would mean a security deposit is like a partnership interest or a share of stock. Nope. Knock (iii) off the list.That leaves (ii). Is a security deposit a "financial instrument or contract"? Well, it certainly is a contract, or a part of the larger rental agreement contract, anyway.But what does the Regulation mean? I think the author of this Regulation means to describe certain technical types of financial instruments used in investments. But the Regulation is badly written. It is susceptible to two meanings:

• "A (financial instrument) or (contract) . . . "; or
• "A financial (instrument or contract) . . . "

In the first interpretation, any contract that has a foreign person on the other side of it will be a "specified foreign financial asset." This means that every contract between a U.S. taxpayer and a non-U.S. person must be disclosed because of Temp. Treas. Reg. Section 1.6038D-3T(b)(1)(ii).The IRS cannot possibly mean that. Can they? (Judgment call: no).So there you have it. You go all of this way to find a sentence with bad syntax, and make a judgment call on what you think the IRS really means to do here. Then and only then do you decide that a security deposit on your personal apartment is not reported on Form 8938.

When a Toaster is Held for Investment

One more bit of badly-written tax law for your enjoyment. Remember that the second definition says that one of the three types of assets will be a "specified foreign financial asset" if it is "held for investment":

Except as otherwise provided in this section, a specified foreign financial asset includes any of the following assets that are held for investment and not held in an account maintained by a financial institution --

Temp. Treas. Regs. Section 1.6038D-3T(b)(1), emphasis added.That phrase -- "held for investment" -- means that an asset is not held for use in a trade or business. Temp. Treas. Regs. Section 1.6038D-3T(b)(3).Think of it. You own a toaster and you use it to make toast for breakfast every morning. It is not used for business at all. According to this definition, you must be holding that toaster for investment.