Establishing Cost-Basis in Foreign Real Estate | IRS Audit Tax Lawyer & Attorney

One of the most challenging issues during an IRS audit is establishing cost-basis in foreign real estate.  This issue most frequently comes up in the context of real estate that was obtained through inheritance or gift many years ago.  In this article, based on my IRS audit experiences, I would like to discuss the main challenges and case strategies associated with establishing the cost-basis in foreign real estate in a manner that would satisfy the IRS during an audit.

An important note: I will not be discussing this issue in the context of an IRS audit of an offshore voluntary disclosure and how it would affect the calculation of an Offshore Penalty.  This essay is strictly limited to an IRS audit that involves US international tax issues without the taxpayer ever going through a voluntary disclosure.

Another important note: this article is written more for the benefit of other international tax lawyers, not the general public.

Establishing Cost-Basis in Foreign Real Estate: Importance

Before we discuss the problems associated with establishing the cost-basis in foreign real estate, we need to first understand why this issue is so important.  There are three main consequences to establishing cost-basis in the context of an IRS audit. 

First, the income tax impact of failure to establish cost-basis in a foreign property on the audited taxpayer may be truly disastrous.  Obviously, if you cannot prove any cost-basis in a property (or you can only convince the IRS that there was minimal cost-basis), you will have to recognize all proceeds from the sale of this property as capital gains (or potentially subpart F income if you owned a property though a foreign corporation).

Second, there is a very important psychological impact on the entire audit if you have a large unreported gain from sale of foreign real estate.  The IRS agent in charge of an audit is likely to take a more aggressive position not only on this issue, but also on other issues irrespective of whether they are directly related to unreported gain.   The most frequent victims of this hardened attitude of an IRS agent are the legal arguments in support of a reasonable cause.

Finally, a large gain from a sale of foreign real estate is likely to encourage the IRS to dig deeper and even expand the audit to more years.  In one of my audit cases, an IRS agent initially believed that there was a large capital gain and expanded the audit to five prior years; however, he reversed this decision once I was able to show that the sold real property had a much higher cost-basis due to numerous improvements that were made by my client over a number of years.

In other words, establishing cost-basis in a sold real estate property may be one of the most crucial issues in an IRS audit.

Establishing Cost-Basis in Foreign Real Estate: Top 3 Challenges

The challenges to establishing cost-basis in foreign real estate are highly dependent on the facts of the case.  However, there are three main themes that usually appear in one form or another in every IRS audit case.

The first challenge is absence of documentation.  This is by far the most common and most important battleground between the IRS and the taxpayer during the vast majority of IRS audits in this area, especially if the direct documentation is absent due to passage of time.

The second challenge is the potential opposition from the IRS to proving cost-basis indirectly through usage of circumstantial evidence and third-parties.

The third challenge is establishing the credibility of evidence. For example, in one of my cases, the IRS initially refused to accept a valuation report prepared by a local professional valuation expert because the report lacked a proper explanation of how he arrived at the proposed values.

Establishing Cost-Basis in Foreign Real Estate: Top 4 Strategies for Overcoming Challenges

There are numerous strategies to deal with the cost-basis establishment challenges. Your choice among them should depend on the facts and circumstances of your case.  Sometimes, you will even come up with a brand-new strategy tailored specifically to the unique challenges of your case.

Nevertheless, there are four common themes to the strategies used in overcoming the aforementioned challenges.  First, you need to recreate the logical history of the property and capital improvements to the property in order to convince the IRS that the valuation your client supplied is logical and reasonable.

Second, demonstrate to the IRS agent in charge of your client’s audit that you are a reliable source of information.  The more objective you appear (and you actually are), the more the IRS sees that you will not allow false facts or statements to enter the record, the more the IRS sees that your client shares both of these traits, the more likely the IRS agent will accept your position or be willing to achieve a compromise with you (see below).

Third, utilize indirect and circumstantial evidence as well as third-party affidavits/testimony to support the valuation of the property.  In other words, if you have no ability to directly establish the cost-basis of a property, then you need to find creative ways to build the necessary records and establish their credibility through usage of supporting documents and/or testimony. 

For example, in one of my previous audits, the client had no documentation whatsoever except one isolated receipt to prove the substantial improvements made to her foreign real estate over the past almost forty (!) years.  My solution to this problem was to first get an affidavit from my client fully stating all improvements made with approximate cost based purely on her memory.  Then, I obtained additional signed statements from neighbors largely supporting the estimates as well as the fact that these improvements were indeed made. Finally, I obtained a statement from a local construction company owner who stated that he recalled these improvements and confirmed the estimated amounts.  Additionally, all of the improvements were properly explained by the history of how the property was obtained, for what purpose and why so many improvements were needed.  All of these facts and circumstances were explained in a letter to the IRS agent together with the legal basis (i.e., case law) showing how courts have accepted similar evidence in the past. Under the weight of this substantial record (and some other circumstances of this case), the IRS finally agreed to accept all improvements as part of an overall compromise.

Finally, use creative legal strategies to convince the IRS to accept a different cost-basis in a property through operation of tax rules.  This is a very complex strategy, but it is more commonly employed than one may believe.  For example, in one of my prior audit cases, the IRS agreed to disregard the foreign corporation that owned the foreign property allowing the stepped-up basis for this inherited property.

Contact Sherayzen Law office for Professional Help with IRS Audits Involving Foreign Real Estate

If you have foreign assets and you are audited by the IRS, contact Sherayzen Law Office for professional help.  We have helped hundreds of US taxpayers around the world to bring their tax affairs in full compliance with US tax laws, including during IRS audits.  We can help you!

Contact Us Today to Schedule a Confidential Consultation!

Tax Residency Starting Date | International Tax Lawyer & Attorney

In situations where a person was not classified as a resident alien at any time in the preceding calendar year and he became a resident alien at some point during current year, a question often arises concerning the tax residency starting date of such a person. This article seeks to provide a succinct overview of this question in three different contexts: US permanent residence, substantial presence test and election to be treated as a tax resident.

Tax Residency Starting Date: General Rule for Green Card Holders

Pursuant to IRC (Internal Revenue Code) §7701(b)(2)(A)(iii), the starting tax residency date for green card holders is the first day in the calendar year in which he or she is physically present in the United States while holding a permanent residence visa.  However, if the green card holder also satisfies the Substantial Presence Test prior to obtaining his green card, the tax residency is the earliest of either the green card test described in the previous sentence or the substantial presence test (see below).

Tax Residency Starting Date: General Rule for the Substantial Presence Test

Generally, under the substantial presence test, the tax residence of an alien starts on the first day of his physical presence in the United States in the year he met the substantial presence test. See IRC §7701(b)(2)(A)(iii).  For example, if an alien meets the requirements of the Substantial presence test in 2022 and his first day of physical presence in the United States was March 1, 2022, then his US tax residency started on March 1, 2022.

Tax Residency Starting Date: Nominal Presence Exception & the Substantial Presence Test

A reader may ask: how does the rule described above work in case of a “nominal presence” in the United States. IRC §7701(b)(2)(C) provides that, for the purposes of determining the residency starting date only, up to ten (10) days of presence in the United States may be disregarded, but only if the alien is able to establish that he had a “closer connection” to a foreign country rather than to the United States on each of those particular ten days (i.e., all continuous days during a visit to the United States may be excluded or none of them). There is some doubt about the validity of this rule, but it has never been contested in court as of the time of this writing.

This rule may lead to a paradoxical result.  For example, if X visits the United States between March 1 and March 10 and leaves on March 10; then later comes back to the United States on May 1 of the same year and meets the substantial presence test, then he may exclude the first ten days in March and his US tax residency will start on May 1.  If, however, X prolongs his visit and leaves on March 12, then none of the days will be excluded (since March 11 and 12 cannot be excluded under the rules) and his US tax residency will commence on March 1.

I want to emphasize that the nominal presence exception only applies in determining an alien’s residency starting date. It is completely irrelevant to the determination of whether a taxpayer met the Substantial Presence Test; i.e. the days excluded under the nominal presence exception are still counted toward the Substantial Presence Test calculation.

Tax Residency Starting Date: Additional Requirements for Nominal Presence Exception & Penalty for Noncompliance

The IRS has imposed two additional requirements concerning claiming “nominal presence” exclusion (again, both of them have questionable validity as there is nothing in the statutory language about them).  First, the alien must show that he had a “tax home” in the same foreign country with which he has a closer connection.

Second, Treas. Regs. §301.7701(b)-8(b)(3) requires that an alien who claims the nominal presence exception must file a statement with the IRS as well as attach such statement to his federal tax return for the year in which the termination is requested. The statement must be dated, signed, include a penalty of perjury clause and contain: (a) the first day and last day the alien was present in the United States and the days for which the exemption is being claimed; and (b) sufficient facts to establish that the alien has maintained his/her tax home in and a closer connection to a foreign country during the claimed period. Id.

A failure to file this statement may result in an imposition of a substantial penalty: a complete disallowance of the nominal presence exclusion claim.  Since IRC §7701(b)(8) does not contain the requirement to file any statements with the IRS to claim the nominal presence exception, the penalty stands on shaky legal grounds.  However, as of the time of this writing, there is no case law directly on point.

Additionally, as almost always in US international tax law, there are exceptions to this rule.  First, if the alien shows by clear and convincing evidence that he took: (a) “reasonable actions” to educate himself about the requirement to properly file the statement and (b) “significant affirmative actions” to comply with this requirement, then the IRS may still allow the nominal presence exclusion claim to proceed. Treas. Regs. 301.7701(b)-8(d)

Second, under Treas. Regs. §301.7701(b)-8(e), the IRS has the discretion to ignore the taxpayer’s failure to file the required nominal presence statement if it is in the best interest of the United States to do so.

Tax Residency Starting Date: Election to Be Treated as a US Tax Resident

In situations where a resident alien elects to be treated as a US tax resident (for example, by filing a joint resident US tax return with his spouse), the tax residency date starts on the first day of the year for which election is made.  See Treas. Regs. §7701(b)(2)(A)(iv).

Contact Sherayzen Law Office for Professional Help with US International Tax Law, Including the Determination of the Tax Residency Starting Date

If you have foreign assets or foreign income or if you are trying to determine your tax residency status in the United States, you should contact Sherayzen Law Office for professional help.  Our law firm is a leader in US international tax compliance; we have helped hundreds of US taxpayers around the world and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

2022 2Q IRS Interest Rates | US International Tax Lawyers

On February 23, 2022, the Internal Revenue Service (“IRS”) announced that the 2022 Second Quarter IRS underpayment and overpayment interest rates (“2022 2Q IRS Interest Rates”) will increase from the first quarter of 2022. This means that, the 2022 2Q IRS interest rates will be as follows:

  • four (4) percent for overpayments (three (3) percent in the case of a corporation);
  • one and one-half (1.5) percent for the portion of a corporate overpayment exceeding $10,000;
  • four (4) percent for underpayments; and
  • six (6) percent for large corporate underpayments.

The second quarter will start on April 1, 2022.

Under the Internal Revenue Code, these interest rates are determined on a quarterly basis. The IRS used the federal short-term rate for February of 2022 to determine the 2022 2Q IRS interest rates. The IRS interest is compounded on a daily basis.

The 2022 2Q IRS interest rates are important for many reasons for US domestic and international tax purposes. For example, the IRS will use these rates to determine how much interest a taxpayer needs to pay on an additional tax liability that arose as a result of an amendment of his US tax return through Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. The IRS will also utilize 2022 2Q IRS interest rates with respect to the calculation of PFIC interest on Section 1291 tax.

As an international tax law firm, Sherayzen Law Office keeps track of the IRS underpayment and overpayment interest rates on a regular basis. Since our specialty is offshore voluntary disclosures, we often amend our client’s tax returns as part of an offshore voluntary disclosure process and calculate the interest owed on any additional US tax liability. In other words these interest rates are relevant to Streamlined Domestic Offshore Procedures, Streamlined Foreign Offshore Procedures, IRS Voluntary Disclosure Practice, Delinquent International Information Return Submission Procedures and Reasonable Cause Disclosures. We also need to take interest payments into account with respect to additional tax liability that arises out of an IRS audit.

Moreover, we regularly have to do PFIC calculations for our clients under the default IRC Section 1291 methodology. This calculation requires the usage of the IRS underpayment interest rates in order to determine the amount of PFIC interest on the IRC Section 1291 tax.

Finally, it is important to point out that the IRS will use the 2022 2Q IRS interest rates to determine the amount of interest that needs to be paid to a taxpayer who is due a tax refund as a result of an IRS audit or amendment of the taxpayer’s US tax return. This situation may also often arise in the context of offshore voluntary disclosures.

Thus, the IRS underpayment and overpayment interest rates have an impact on a lot of basic items in US tax law. Hence, it is important to keep track of changes in these rates on a quarterly basis.

Offshore Voluntary Disclosure Seminar | MSBA, February 22 2022

On February 22, 2022, Mr. Eugene Sherayzen, an international tax attorney and founder of Sherayzen Law Office, Ltd., presented at a seminar “IRS Voluntary Disclosure Options for U.S. Owners of a Foreign Business” (the “Offshore Voluntary Disclosure Seminar”). The Offshore Voluntary Disclosure Seminar was sponsored by the International Business Law Section of the Minnesota State Bar Association. Due to the ongoing COVID-19 pandemic restrictions, the seminar was conducted online.

Offshore Voluntary Disclosure Seminar: Focus on Business Lawyers’ Needs

The seminar’s structure was shaped by its audience’s needs. Since Mr. Sherayzen presented to a group of mostly international business lawyers, he adopted a relatively broad approach in his presentation in attempt to cover a large number of topics rather than discuss a few points in depth. The idea behind the seminar was to provide international business lawyers with analytical tools to understand if there was problem with a client’s US international tax compliance that would require a utilization of an offshore voluntary disclosure option.

Offshore Voluntary Disclosure Seminar: Three Main Parts

Mr. Sherayzen divided the Offshore Voluntary Disclosure seminar into three parts. In the first and smallest part, he discussed the link between Offshore Voluntary Disclosures and international business law. The second part focused on US international tax reporting requirements. Finally, in the third part, the international tax attorney provided a broad overview of the existing offshore voluntary disclosure options.

Offshore Voluntary Disclosure Seminar: Link between Offshore Voluntary Disclosures and International Business Law

In the first part of the seminar, Mr. Sherayzen discussed the potential relevance of the IRS offshore voluntary disclosure options and US international tax law in general to the audience’s international business law practice. The international tax attorney even described three main scenarios where international business lawyers will need to have awareness of: US international tax reporting requirements and IRS offshore voluntary disclosure options for US owners of a foreign business. At that point, Mr. Sherayzen gave an example from his own practice illustrating his main points.

Offshore Voluntary Disclosure Seminar: Overview of US International Tax Reporting Requirements for US Owners of a Foreign Business

In the next part of the Offshore Voluntary Disclosure seminar, Mr. Sherayzen provided a broad overview of two major categories of US international tax reporting requirements for individual US taxpayers: US international information returns and income tax recognition.

The international tax attorney first focused on international information returns. After defining the term “information return”, Mr. Sherayzen stated that the type of an information return one needs to file should correspond to the type of a foreign entity for which the return is filed. Then, he described three types of entities that may exist under US international tax law: corporations, partnerships and disregarded entities. Mr. Sherayzen proceeded with a discussion of the most common information returns associated with each of them.

Moreover, the attorney explained that FinCEN Form 114 or FBAR is the main form for reporting of foreign bank and financial accounts in a business context. He also warned the audience against a potential tax trap associated with FBAR reporting for foreign business entities.

Then, Mr. Sherayzen proceeded with an explanation of three major categories of income recognition: distributions, passthrough income and US anti-deferral tax regimes. The latter received the most attention due to their complexity. Three anti-deferral tax regimes were covered: PFICs, Subpart F rules and GILTI.

Offshore Voluntary Disclosure Seminar: Offshore Voluntary Disclosure Options

Mr. Sherayzen began this last major part of his presentation with a definition of the term “offshore voluntary disclosure”. Then, he focused on explaining two critical factors in choosing a voluntary disclosure option: (a) willfulness vs. non-willfulness; and (b) reasonable cause.

After defining these highly-important terms, the attorney laid out all major offshore voluntary disclosure options available to US owners of a foreign business. The presentation covered: IRS Voluntary Disclosure Practice, Streamlined Domestic Offshore Procedures, Streamlined Foreign Offshore Procedures, Delinquent FBAR Submission Procedures, Delinquent International Information Return Submission Procedures and Reasonable Cause (Noisy) Disclosure.

Mr. Sherayzen also discussed the concept of quiet disclosure and why it presented potentially huge risks to noncompliant taxpayers. He emphasized that the IRS stated in the past that it would specifically target this type of a disclosure.

Offshore Voluntary Disclosure Seminar: Conclusion

The international tax attorney concluded the seminar with a concise due diligence plan of action for business lawyers. He emphasized that, upon discovery of potential US international tax noncompliance, business lawyers should not attempt to fix it themselves. Rather, he argued, they need to contact an international tax attorney for professional help.

Contact Sherayzen Law Office for Professional Help

If you are a US owner of a foreign business and you have not properly complied with your US international tax reporting requirements, contact Sherayzen Law Office for professional help. We have helped hundreds of US taxpayers around the globe to bring their US tax affairs into full compliance with US international tax law, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Austin Business Trip | February 2022 | International Tax Lawyer & Attorney

In early February of 2022, Mr. Sherayzen, an international tax attorney and owner of Sherayzen Law Office, Ltd., traveled to Austin, Texas. Let’s discuss this Austin business trip in more detail.

Austin Business Trip: Goals

While the business trip to Austin was very short, Mr. Sherayzen set forth three main goals for the trip: (1) meeting with a client; (2) familiarizing himself with the city, which is a major source of clients to the firm; and (3) conducting important marketing activities to promote the firm.

All of these goals were accomplished (though #2 may still need more work) despite the fact that he came to Austin at the worst possible moment – right after a winter storm when the temperatures plummeted to the twenties (Fahrenheit) from the usual upper fifties/lower sixties and there was still ice on the roads.

Austin Business Trip: Client Meeting

The first goal was very easy to achieve as the meeting with a client was set prior to his arrival to Austin.

Austin Business Trip: Getting to Know Austin

The weather and the brevity of the Austin business trip presented a formidable challenge to the second goal. Despite these problems, Mr. Sherayzen was able to familiarize himself with the old-city Austin. Even more important, he was able to visit the IRS campus in Austin that processes streamlined disclosures: Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. Both of these options are known as Streamlined Compliance Procedures.

Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures belong to the core practice of Sherayzen Law Office. This is why visiting the Austin IRS campus was an indispensable part of the Mr. Sherayzen’s trip to this city.

One may ask: why does Mr. Sherayzen want to know Austin in person? The answer is very simple: he wants to understand how his clients live, what their particular needs are, what logistical problems they may be facing and what are the peculiarities of their everyday life. At Sherayzen Law Office, we take an extra step in delivering customized services to our clients; for this reason, we strive to understand not only the financial situation of our clients, but also their logistics.

Austin Business Trip: Marketing

Marketing is Mr. Sherayzen’s crucial goal in almost every business trip. Nothing can replace the authenticity of marketing materials made in the city where the client lives. For this reason, more than two-thirds of his trip to Austin was devoted to marketing activities.

Given the presence of an IRS campus in Austin, offshore voluntary disclosures of course constituted the focus of these marketing activities. Besides Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures, Mr. Sherayzen also covered IRS Voluntary Disclosure Practice and other voluntary disclosure options.

Additionally, as always, Mr. Sherayzen promoted the awareness of the FBAR and FATCA reporting requirements in his marketing activities. The attorney also covered important US international tax information returns such as: Forms 8865, 5471, 3520, 3520-A, et cetera.

Austin Business Trip is Part of a Major Marketing Strategy

The Austin business trip is merely one part of a major marketing strategy that Sherayzen Law Office launched last year. It is projected that this strategy will run through the end of the year 2027.

Contact Sherayzen Law Office for Professional Help With Your Offshore Voluntary Disclosure and US International Tax Compliance

Sherayzen Law Office is an international tax law firm that specializes in US international tax compliance and offshore voluntary disclosures. We help clients with their US international tax compliance issues throughout the world, including in all fifty states of the United States.

Contact Us Today to Schedule Your Confidential Consultation!