taxation law services

Foreign Rental Property Tax Depreciation

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Do you own, or are you thinking of owning, foreign rental property?  While investing in foreign rental property may have many advantages and can be a potentially lucrative enterprise, you should be aware that, among other aspects, the IRS treats rental properties located outside of the United States differently than rental properties in the United States with respect to the depreciation deduction.  This article explains some of the basic differences in the depreciation treatment of such properties.

Depreciating US Residential Rental Property

The IRS defines “residential rental property” to include rental buildings or structures for which 80% or more of the gross rental income for the tax year is from dwelling units.

In general, for residential rental property located within the United States, taxpayers must depreciate the property using the straight-line method over 27.5 years.   Furthermore, the mid-month convention for residential rental property should be used.  In the first year that depreciation is claimed for residential rental property, it can be claimed only for the number of months the property is in use as a rental.

Depreciating Foreign Residential Rental Property

The IRS rules for depreciating residential rental property located outside the United States, however, are different.  Under IRC section 168(g)(1)(A), “any tangible property which during the taxable year is used predominantly outside the United States” must use the alternative depreciation system.  When using the alternative depreciation method specified in the Internal Revenue Code, foreign rental properties must be depreciated over a much longer 40 year period.  This means that the depreciation that may be deducted for a foreign rental property will smaller than if the same property (at the same purchase price, disregarding currency fluctuations) were located within the United States.

Contact Sherayzen Law Office For Legal Help With Rental Properties

There are other potentially complex issues relating to foreign and US residential rental properties that are beyond the scope of this general explanation, as this article only attempts to provide background information that should not be relied upon in making the determination of your specific situation. Rather, you should contact Sherayzen Law Office for legal help with this issue. Our experienced international tax firm will guide you through the complex web of rules concerning your U.S. and international tax needs.

Form 8865 Penalties

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IRS Form 8865 (“Return of U.S. Persons with Respect to Certain Foreign partnerships”) is used to report information required under IRC section 6038 (reporting with respect to controlled foreign partnerships), IRC section 6038B (reporting of transfers to foreign partnerships), and IRC section 6046A (reporting of acquisitions, dispositions, and changes in foreign partnership interests) for those taxpayers who are required to file.

In a previous article, I broadly described the four categories of filers who are required to file the form. This article will examine the penalties that may be imposed for failure to comply with the IRS requirements.

Penalties

A. Failure to Timely Submit all Required Information Concerning Category 1 and 2 Filers

Form 8865 must be filed along with an income tax (or partnership or exempt organization) return by the due date, including extensions, of the return. For persons who must file Form 8865, but who are not required to file an income tax (or other applicable) return, the form must be submitted to the IRS at the time and location that such a return would have been filed, if the person had been required to do so.

A $10,000 penalty may be imposed (for each tax year) of each foreign partnership for a failure to furnish all of the necessary information by the required time. Further, if the information is not filed within 90 days after the IRS has mailed a notice of the failure to a U.S. person, another $10,000 penalty per foreign partnership may be charged for each 30-day period (or fraction thereof), during which the failure continues after that 90-day period has expired. This additional penalty is limited to a maximum of $50,000 for each failure.

Additionally, any person who fails to furnish all of the necessary information within the required time period will be subject to a reduction of 10% of the foreign taxes credit under IRC sections 901, 902, and 960. Furthermore, an additional 5% reduction will result for each 3-month period (or fraction thereof), after the 90 day time period, in which the IRS mailed the notice of the failure, has expired. IRC section 6038(c)(2) limits the amount of this penalty.

The above-mentioned penalties have a much broader application. They may also apply to any person who does not meet the “constructive owners” exception (contact an international tax attorney for details with respect to this issue) but who files Form 8865 stating that the exception is met. Likewise, where another person files under the “multiple Category 1 filers exception” (see below) for the taxpayer who is required to file Form 8865 and the filer fails to accurately complete the Form and applicable schedules, the same drastic penalties may apply to the taxpayer (even though the actual filer, and not the taxpayer, is at fault).

Generally, the “multiple Category 1 filers exception” provides that, if during the tax year of a partnership more than one U.S. person qualifies as a Category 1 filer, only one of the Category 1 partners may be required to file Form 8865

Finally, the criminal penalties under IRC sections 7203, 7206, and 7207, may also be applied to the above-mentioned groups for failure to file or for filing false or fraudulent information. You will need to consult an international tax attorney to determine whether criminal penalties may potentially apply in your situation.

B. Failure to File Required Information Concerning Category 3 Filers

The penalties for the Category 3 filer (see this article for definition) may be truly draconian. Where a Category 3 filer fails to properly report a contribution to a foreign partnership that is required to be reported under section 6038B and applicable regulations, the filer may be subject to a penalty equal to 10% of the fair market value of the property at the time of the contribution. In addition to the penalty, the person must treat the contributed property as having been sold at the fair market value at the time of transfer, and recognize gain on the disposition for tax purposes. Unless the failure resulted because of intentional disregard, this penalty may be limited to a $100,000.

C. Failure to File Required Information Concerning Category 4 Filers

Any person who fails to accurately report all of the required information under section 6046A (reporting of acquisitions, dispositions, and changes in foreign partnership interests) may be subject to a $10,000 penalty.

If the failure to report continues for more than 90 days after the IRS mails a notice of the failure, an additional $10,000 penalty will apply for each 30-day period (or fraction thereof) that the person fails to correct the failure, after the 90-day period has expired. This additional penalty will be limited to $50,000.

D. Failure to Report Treaty-Based Return Positions

Persons who are claiming a treaty-based position that an existing treaty between the US and another nation either overrides or modifies any IRC provision, or reduces, or possibly reduces, a tax incurred at any time, must file Form 8833 (“Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)”). Failure to file this form for a treaty-based position may result in a $1,000 penalty Under IRC section 6712. For C corporations, the penalty is $10,000.

Correcting Form 8865

Because of the severity of the penalties that may apply for an erroneous or incomplete Form 8865, individuals should be aware of the procedures available for correcting the form, if necessary. If an incorrect or incomplete form has been filed, a corrected form should be filed with an amended tax return (stating “corrected” at the top of the form), and a sheet attached specifying and explaining the corrections.

Contact Sherayzen Law Office For Legal Advice In Dealing With Form 8865 Penalties

Form 8865 penalties can be extremely large, and, in certain circumstances, disastrous to your personal and financial life. Therefore, if you believe that you are potentially facing a Form 8865 penalty, contact Sherayzen Law Office immediately for a legal advice. Our experienced international tax compliance firm will vigorously and professionally defend your interests, represent you in all of your IRS dealings, and strive to achieve the most favorable outcome while dealing with this highly complex and stressful situation in an expeditious manner.

Form 8865: Categories of Required Filers

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For taxpayers who are required to file IRS Form 8865 (“Return of U.S. Persons with Respect to Certain Foreign partnerships”) is used to report required information under IRC section 6038 (reporting with respect to controlled foreign partnerships), IRC section 6038B (reporting of transfers to foreign partnerships), and IRC section 6046A (reporting of acquisitions, dispositions, and changes in foreign partnership interests). For purposes of these requirements, a “foreign partnership” is defined to be a partnership that is not created or organized in the United States or under the law of the United States or of any state.

Since the penalties for the failure to accurately file Form 8865 can be severe, it is important to recognize who is required to file the Form. This article examines which taxpayers are generally required to file the Form, and explores the four categories of filers who must report the required information.

Who Must File Form 8865

U.S. persons who meet one or more of the four categories of filers (explained below) must complete and file Form 8865. It is important to remember that the Form may require the taxpayer to file additional schedules and other information (the additional filing information will usually depend upon the taxpayer’s filing category). You should consult an international tax attorney on what information should be disclosed on Form 8865, including additional schedules and attachments.

Four Categories of Filers

Category 1 Filers

A category 1 filer is a U.S. person who controls a foreign partnership at any time during the partnership’s tax year. “Control” of a partnership is defined to be ownership of more than a 50% interest in the partnership. Under IRS rules, a 50% interest in a partnership is an interest equal to 50% of the capital, 50% of the profits, or 50% of the deductions or losses. Additionally, for purposes of determining a 50% interest, highly complex IRS indirect and constructive ownership rules may apply.

The various partnership control interest rules mean that it is possible to have multiple Category 1 filer in a foreign partnership.

Category 2 Filers

A category 2 filer is a U.S. person, who at any time during the foreign partnership’s tax-year, owned a 10% or greater interest in the partnership while the partnership was controlled by U.S. persons each owning at least 10% interests. A 10% interest in a partnership is an interest equal to 10% of the capital, 10% of the profits, or 10% of the deductions or losses. In addition, indirect and constructive ownership rules also apply to determining whether there is a 10% interest.

An interesting exception may apply where a partnership has a category 1 filer at any time during a tax year. You will need to consult an international tax attorney on whether such exception applies in your case and what are the consequences.

Category 3 Filers

A Category 3 filer is defined to be a U.S. person, who in exchange for an interest in the partnership, contributed property during that person’s tax year to a foreign partnership (an IRC section 721 transfer), if that person meets one of two requirements: 1) The taxpayer either owned, directly or constructively, at least a 10% interest in the foreign partnership immediately after the transfer, or 2) The value of the property contributed, when added to the value of any other property contributed to the partnership by such person (or related persons under IRS rules), during the 12-month period ending on the date of transfer, exceeded $100,000.

Additionally, U.S. persons who previously transferred appreciated property to the partnership (and were required to report that contribution under section 6038B) will qualify as category 3 filers if the foreign partnership disposed of such property while the U.S. person remained a direct or indirect partner in the partnership.

Furthermore, if a domestic (US) partnership contributes property to a foreign partnership, the domestic partnership’s partners are deemed to have transferred a proportionate share of the contributed property to the foreign partnership. The domestic partners, however, are not likely to be required to report the transfer provided that the domestic partnership files Form 8865 and properly reports all the required information with respect to the contribution.

Category 4 Filers

A Category 4 filer is a U.S. person who has a reportable event under IRC section 6046A during that person’s tax year. Under section 6046A, there are three categories of reportable events: acquisitions, changes in proportional interests, and dispositions.

A. Acquisitions

A U.S. person who acquires a foreign partnership interest has a reportable event if: 1) That person did not previously own a 10% or greater direct interest in the partnership and as a result of the acquisition, the person now owns a 10% or greater direct interest in the partnership (for example, from 8% to 10%). For purposes of this rule, an acquisition includes an increase in a person’s “direct proportional interest” (defined below); or 2) Compared to the person’s direct interest when the person last had a reportable event, after the acquisition, the person’s direct interest has now increased by at least 10% (for example, from a 13% interest to a 23% interest).

B. Changes in a Proportional Interest

A partner’s proportional interest in a foreign partnership can change as a result of changes in other partners’ interests. Some examples include when another partner withdraws from a partnership, or by operation of the partnership agreement (i.e., a partnership agreement may state that a partner’s interest in profits will change on a set date or when the partnership has earned a specified amount of profits, thus changing the proportional interest in the partnership).

C. Dispositions

A U.S. person who disposes of a foreign partnership interest has a reportable event if: 1) The person previously owned a 10% or greater direct interest in the partnership before a disposition, and as a result of the disposition, the person now owns less than a 10% direct interest (for example, from 10% to 9%). (A disposition also includes a decrease in a person’s direct proportional interest for purposes of this rule); or 2) Compared to the person’s direct interest when the person last had a reportable event, after the disposition the person’s direct interest has now decreased by at least 10% (for example, from a 22% interest to a 12% interest).

Exemptions

While this is outside of the scope of this essay, I want to mention that there are certain exemptions from Form 8865 filing requirements may be applicable depending upon the facts of a US person’s case. You need to consult an international tax attorney to determine whether your situation is compatible with any of the exemption categories.

Contact Sherayzen Law Office for Legal Help With Form 8865

The filing of Form 8865 involves complex legal and tax issues, and this article only attempts to provide a very general background information that should not be relied upon in making the determination of your specific situation. Rather, you should contact Sherayzen Law Office for legal help with this issue. Our experienced international tax firm will help you determine whether you need to file Form 8865, and help you to properly draft and file the Form. We can also help you with any voluntary disclosure matters involving Form 8865.

Underpayment and Overpayment Interest Rates for the First Quarter of 2012

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On November 29, 2011, the Internal Revenue Service announced that underpayment and overpayment interest rates will remain the same for the calendar quarter beginning January 1, 2012. The rates will be:

  • three (3) percent for overpayments (two (2) percent in the case of a corporation)
  • three (3) percent for underpayments
  • five (5) percent for large corporate underpayments
  • one-half (0.5) percent for the portion of a corporate overpayment exceeding $10,000

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points. Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points.

The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

Notice 88-59, 1988-1 C.B. 546, announced that, in determining the quarterly interest rates to be used for overpayments and underpayments of tax under section 6621, the Internal Revenue Service will use the federal short-term rate based on daily compounding because that rate is most consistent with section 6621 which, pursuant to section 6622, is subject to daily compounding.

Interest factors for daily compound interest for annual rates of 0.5 percent are published in Appendix A of Revenue Ruling 2011-32. Interest factors for daily compound interest for annual rates of 2 percent, 3 percent and 5 percent are published in Tables 7, 9, 11, and 15 of Rev. Proc. 95-17, 1995-1 C.B. 561, 563, 565, and 569.

Form 8938 New Foreign Asset Reporting Requirements: Introduction

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In its continuous efforts to combat tax evasion, the IRS imposed a brand-new foreign asset reporting requirements on U.S. persons.  For the very first time, starting tax year 2011 (with certain exceptions), certain individuals must file the new Form 8938 to report the ownership of specified foreign financial assets if the total value of those assets exceeds an applicable threshold amount.

This threshold amount differs depending on the particular situation of a U.S. person – whether an individual lives in the United States, is married and filing a joint income tax return, et cetera.

The “specified foreign financial assets” include any financial account maintained by foreign financial institution and certain investment assets such as stock, securities or any other interest in a foreign entity and any financial instrument or contract with an issuer or counterparty who is not a U.S. person.

Based on this description alone, it becomes obvious that the new Form is likely to impose a higher reporting burden than the famous FBARs.   Note that Form 8938 does not replace the FBAR reporting requirements – i.e. the FBARs must still be filed by June 30 (former FBAR due date) of a relevant year in addition to Form 8938.

Unlike the FBAR, Form 8938 is attached to the filer’s annual tax return and must be filed by the due date (including extensions) for that return.  An annual return includes the following forms: Form 1040, Form 1120, Form 1065, Form 1120-F, Form 1120-S, and Form 1040NR (of a nonresident alien who is a bona fide resident of Puerto Rico or American Samoa).

Note that Form 8938 imposes new failure-to-file and accuracy-related penalties, which are very severe and may be combined with other penalties.  Moreover, failure to file an accurate Form 8938 may extend the statute of limitations for all or a part of your income tax return until three years after the date on which you file Form 8938.

Note that, pursuant to Notice 2011-55, the IRS provides for a transitional rule for the year 2011 which may defer your obligation to file Form 8938 until the tax year 2012 as long as you satisfy all of the three requirements of the transitional rule.

Contact Sherayzen Law Office For Legal Help With Form 8938

This article highlights a few features of the new Form 8938 and it should not be relied upon in determining whether you are obligated to file Form 8938.  Form 8938 is fairly complex and you need professional help to determine how to comply with the Form’s requirements.

If you have any questions with respect to Form 8938, please contact Sherayzen Law Office.  Our experienced international tax firm will help you determine whether you must file Form 8938 and help you draft and file the form with your tax return in order to avoid the heavy IRS penalties for non-compliance.