Note: this is another answer for the accountants who took my all-day courses in Pleasanton in January.
The “Net Election” is an election by a nonresident of the United States who owns U.S. real estate. This is an almost mandatory election for a nonresident investor. The default U.S. income tax paid by a nonresident on rental income is 30% of the total rent received, without any allowance for operating expenses. The “Net Election” changes a nonresident’s U.S. income tax treatment so that the nonresident is taxed exactly as a U.S. resident is taxed — on the net income (rent collected minus operating expenses) from the property.
The “Net Election” takes its name from the fact that it changes the income tax payable by the nonresident investor to a method by which that investor is tax on net income.
Sometimes partnerships are used to hold U.S. real estate. A nonresident individual or a non-U.S. corporation will be the partner. In that case, who makes the Net Election — the partnership or the foreign partner?
Answer: the election is made by the foreign partner. The nonresident individual makes this election on Form 1040-NR, while a foreign corporation makes the election on Form 1120-F.
If a non-resident alien individual or foreign corporation is a member of a partnership which has income described in paragraph (b)(1) of this section from real property, any election to be made under this section in respect of such income shall be made by the partners and not by the partnership. [Emphasis added.] A nonresident alien or foreign corporation that makes an election generally must provide the partnership a Form W-8ECI, “Certificate of Foreign Person’s Claim for Exemption from Withholding on Income Effectively Connected with the Conduct of a Trade or Business in the United States,” and attach to such form a copy of the election (or a statement that indicates that the nonresident alien or foreign corporation will make the election). However, if the nonresident alien or foreign corporation has already submitted a valid form to the partnership that establishes such partner’s foreign status, the partner shall furnish the partnership a copy of the election (or a statement that indicates that the nonresident alien or foreign corporation will make the election). To the extent the partnership has income to which the election pertains, the partnership shall treat such income as effectively connected income subject to withholding under section 1446. See also section 1.1446-2.
Citation: Treasury Regulations Section 1.871-10(d)(3).
Action step: if you are a nonresident investor in a partnership that holds U.S. real property, check to see that you have taken the necessary action steps to be taxed on net income rather than gross income.
Phil Hodgen
Philip D. W. Hodgen is the principal attorney of HodgenLaw PC, an international tax law firm based in Pasadena, California. He earned his undergraduate degree from Claremont McKenna College and his law degree from the School of Law at the University of California, Los Angeles. He then went on to earn a Master of Laws degree with a specialty in taxation from the University of San Diego School of Law. Admitted to the California bar in 1982, Phil spent nine years in law firms and with a large U.S. bank before starting his own firm in 1991.
Phil is a past chair of the International Tax Committee of the State Bar of California's Tax Section and was a member of the Executive Committee of the State Bar of California's Tax Section for 2004-2007. Phil frequently speaks on a variety of international tax, trust and estate topics to attorneys, accountants, and real estate professionals.
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Tax laws change over time, and the information in this post above may be less accurate today than it was at the time of the last revision. This post is not tax advice for your specific situation. Please contact an international tax professional to get personalized advice for your situation.
