October 24, 2008 - Phil Hodgen

The “net election” for nonresident landlords

This is for the members of my Foreign Investment in U.S. Real Estate Class earlier this week in San Francisco.

We talked about the “net election.” Here’s the detail I promised.

The law

To learn everything about this, read Treasury Regulations Section 1.871-10. (PDF).

The effect

Rental income earned by a nonresident owner of U.S. real estate (human or corporation, it doesn’t matter) is taxed harshly by default — 30% of gross rent received is the tax, with no deduction for business expenses. You know, the little things. Stuff like mortgage interest, depreciation, property tax, management fees. That kind of stuff.

By making the election you can change the Federal taxation to the normal method: the nonresident real estate owner would be taxed on gross rent collected less allowable expenses.

The choice does not require a lot of thought. “30% off the top?? or 30%-ish off the bottom?”

(Note that this is for Federal income tax, not California income tax).

How to do it

You make this election by attaching a statement to the income tax return.

Here’s what the Regulations require:

An election made under this section without the consent of the Commissioner shall be made for a taxable year by filing with the income tax return required under section 6012 and the regulations thereunder for such taxable year a statement to the effect that the election is being made. This statement shall include (a) a complete schedule of all real property, or any interest in real property, of which the taxpayer is titular or beneficial owner, which is located in the United States, (b) an indication of the extent to which the taxpayer has direct or beneficial ownership in each such item of real property, or interest in real property, (c) the location of the real property or interest therein, (d) a description of any substantial improvements on any such property, and (e) an identification of any taxable year or years in respect of which a revocation or new election under this section has previously occurred. This statement may not be filed with any return under section 6851 and the regulations thereunder.

When it’s effective

It’s effective for the year that you filed, and goes forward into the future until you toggle it off.

And yes you can go back in time, file an amended return, and make it effective then. If you are within the statute of limitations for claiming a refund, you can file this election.

Memo to all personnel

Do it.

Foreign Business Activities in the USA US Real Estate Investments