Chinese Client Owns US Rental Property - Tax Liability?

[gregt75]

Good News - Form W8 Ben

I spoke with him (Chinese client) and he said the agent last year made him fill out the form W8 Ben when he purchased the place. He is getting a copy for us. He does not, however, have an ITIN. I told him that a W7 needs to be filled out so we can then get an ITIN and then fill out a 1040NR to file his taxes.

[AZUKHiker]

Yes it is ECI

As a NR with rental income the Chinese person can elect for the US rental to be taxed as ECI, claim the usual rental expenses and be taxed at the US graduated rates. That is standard tax planning for a NR with US property income.

However, your friend as the agent has more important issues. Unless the Chinese person has an ITIN and has completed one of the W8 forms your friend as agent is required to withhold 30% from the rental payments and account to the IRS for those withholdings. The 30% would only stop once the Chinese person gets an ITIN and completes one of the W8 forms to confirm he has or will make the ECI election.

[gregt75]

My mistake on the personal property

I misread the information. From what I read about ECI, he has to actively be involved in a US trade or business. This would not apply to him.

[Koss]

Real Property

Just a couple of observations:

As noted by Gary2, real estate is not personal property.

On the fact pattern presented, the guy is a nonresident alien who must file Form 1040-NR. MFJ is not an option, unless there is some provision for it in the tax treaty. Nonresident aliens generally cannot file MFJ. There are exceptions for citizens of certain countries. China is not one of those countries.

Form 8938 is not applicable here. Form 8938 is only filed by US citizens, US residents, and nonresident aliens who elect to be treated as resident aliens.

The election to be treated as a resident alien is not available on this fact pattern, and even it were, it would probably be a terrible idea.

I am not going to offer an opinion on whether he can choose to have the income treated as "effectively connected income." If he can, that may well be beneficial.

The property manager, who is a friend of the original poster, is talking about "walking away." But it may be too late for that. I would have to have more facts, and do some research, in order to draw any conclusion, but he may already be subject to specific reporting requirements that apply to anyone who makes payments to a nonresident alien. He may even be considered a withholding agent, for purposes of the 30% withholding tax. If he has already made payments to the Chinese property owner, then he may have to issue information returns that are specific to nonresident aliens. And he may have to dig himself out of a hole (or get professional help doing so) if he was required to withhold tax and did not do so. If he is already in this situation, "walking away" will not solve the problem, and could make things worse.

It is worth noting that it is not clear from the original post whether the property manager is a client of the poster. The poster states that the Chinese citizen is a potential client, and that the property manager is a friend. It does not tell us whether the property manager is also a client.

In theory, there might even be a conflict of interest between the property manager and the property owner. But that's kind of a stretch. There probably is no conflict of interest. If both the property manager and the property owner want to fully comply with US tax laws, then the same tax pro should be able to do tax returns for both the manager and the owner (including any required information returns and withholding reports) without any problems.

The current issue of the EA Journal, published by the National Association of Enrolled Agents, has a very good article that discusses the reporting and withholding requirements that apply to payments made to foreign persons.

The article is not accessible online unless you are a member of NAEA. However, I invite gregt75 to contact me directly for some details.

BMK

[Gary2]

Based on the site below, he cannot elect to treat it as ECI since it is personal property with rental income.

Forgive me if I'm missing something, but isn't this real estate? If so, that's not personal property.

[gregt75]

Owner is Chinese Citizen

The owner is a Chinese citizen living in China. I do not believe he can elect as effectively connected business because he has no business dealings here in America. From everything I read, it sounds like he has to pay 30% on the gross income. Based on the site below, he cannot elect to treat it as ECI since it is personal property with rental income. The property manager is a friend of mine. He might have to walk away because he could be held liable for the taxes from what I read. If anyone knows any loopholes, that would be great. I briefly looked at the treaty but did not see anything.

I looked at this site, http://www.deloitte.com/assets/dcom-...uide032510.pdf

Net basis elections
Code §§ 871(d) and 882(d) allow a foreign corporation or international investor that derives income from real
property, but that is not engaged in a U.S. trade or business (e.g. the investment is raw land or net leased
property) to elect to be taxed on a net basis at graduated rates as if the income were ECI. This “net basis
election” can be beneficial, because the production of realty income generally involves substantial expense. Upon
making the election, the investor is relieved of the 30% tax on gross rents and is allowed to deduct expenses
associated with the real estate, such as depreciation and interest. Often these expenses exceed income and
therefore no U.S. tax is due. The Code net basis election may be revoked only with consent of the Secretary of
the Treasury and applies to all U.S. real estate held at the time of the election, as well as to property that may be
acquired in the future. Further, the net basis election applies to all income from real property that is located in the
United States and held for the production of income. The election does not, however, apply to certain income,
including:
· Interest income on a debt obligation secured by a mortgage on U.S. real property;
· Rental income from personal property; and
· Income from real property, such as a personal residence, that is not held for the production of income.

[mastertaxguy]

...and this is not a stupid question. You said he has a managing company. Does this mean he personally owns the rental, or is it owned by a corporation or some other entity (foreign or domestic)?

I believe he has an obligation to file and pay USTaxes just the same as any foreign investor. Not familiar with all the twists and turns, but he may have the choice between filing a MFS and paying on only his US investment income, or filing MFJ and paying on his worldwide income, with credits for foreign taxes. And don't forget Form 8938 and the question about foreign accounts at the bottom of Sch B.

I think you either walk away from this one, or else commit yourself to learning a lot about aliens, resident and non-resident.

I'm going to ask a friend to comment, if she will.

1. Facts do not indicate the potential client is a US resident.
2. Perhaps poster should consult the US-China tax treaty available through the IRS web site.

[Gary2]

Can he make the election to have it treated as an effectively connected business?

[Corduroy Frog]

Who is the Owner

...and this is not a stupid question. You said he has a managing company. Does this mean he personally owns the rental, or is it owned by a corporation or some other entity (foreign or domestic)?

I believe he has an obligation to file and pay USTaxes just the same as any foreign investor. Not familiar with all the twists and turns, but he may have the choice between filing a MFS and paying on only his US investment income, or filing MFJ and paying on his worldwide income, with credits for foreign taxes. And don't forget Form 8938 and the question about foreign accounts at the bottom of Sch B.

I think you either walk away from this one, or else commit yourself to learning a lot about aliens, resident and non-resident.

I'm going to ask a friend to comment, if she will.

[ATSMAN]

Well if this Chinese fellow want to come and actively manage his rental, he may be in a better tax position!

[gregt75]

I have potential Chinese client who owns US property and is renting it out. He has a managing company take care of all the administrative duties. From what I gather from the IRS site, http://www.irs.gov/Individuals/Inter...-Real-Property, he will owe 30% on his gross income and cannot deduct any expenses since it is considered passive activity. Is there any way to reduce this liablity? Please advise. Thanks.