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Tax Tips: Nonresident taxation of US rental real estate

Resident and nonresident aliens are taxed in different ways.  Resident aliens are generally taxed in the same way as US citizens.  Nonresident aliens are taxed based on the source of their income and whether or not their income is effectively connected with a US trade or business.  A nonresident alien’s income that is subject to US income tax must be divided into two categories:
  1. Income that is effectively connected with a trade or business in the US, and
  2. Income that is not effectively connected with a trade or business in the US.

The difference between these two categories is that effectively connected income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. Income that is not effectively connected is taxed at a flat 30% (or lower treaty) rate.

Nonresident taxation of US rental real estate

Nonresident taxation of US rental real estate

However, if you have rental real estate you can elect to have it treated as a US trade or business for tax purposes.  If you make this choice, you can claim deductions attributable to the real property income and only your net income from real property is taxed.  If you make this election, you must attach a statement to your tax return that addresses the following:

  • That you are making the choice;
  • Whether the choice is under IRC section 871(d) (explained above) or a tax treaty;
  • A complete list of all your real property, or real property interests, located in the US;
  • The extent of your ownership in the property;
  • The location of the property;
  • A description of any major improvements to the property;
  • The dates you owned the property;
  • Your income from the property.
  • Details of any previous choices and revocations of the real property income choice.

Now let’s take a look at non-resident taxation of US rental real estate.  Let’s assume you are a nonresident alien and you are not engaged in a U.S. trade or business. You own a single family residence in the US that you rent out. Your rental income for the year is $10,000 and this is your only US source income. In addition, you have $6,000 in expenses, which includes property management fees, insurance, property taxes, repairs and maintenance, depreciation and other miscellaneous costs.  The rental income would normally be subject to a tax at a 30% (or lower treaty) rate, which would amount to $3,000.

But if you make the election discussed above, you can offset the $10,000 income by all of your rental expenses. You are then tax on the net income of $4,000 (reduced by your exemption and any itemized deductions).  Any resulting net income is taxed at graduated rates.  The result is a tax savings of potentially thousands of dollars.

Nonresident taxation of US rental real estate

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