Hello and welcome to this Edition. I’m Maximiliano Mira Salas, and here I share topics on international taxation. Please tell your friends.
Today I want to tell you about a consultation I received from Jorge B., a client who came to FINANCERS seeking tax advice for purchasing property in the U.S. His situation is one of many we see regularly, and you will probably identify if you are in a similar position.
Summary
Here is what happens.
A nonresident signs a contract to purchase real estate in the U.S., which is considered a «U.S. real property interest.»
The nonresident, Jorge, seeks tax advice regarding ownership structures.
Instead of completing the purchase and taking title as an individual, Jorge creates a holding structure and assigns the rights under the purchase contract to that newly created structure, which then completes the purchase.
That assignment of rights under the purchase contract is a «disposition» of a «U.S. real property interest» triggering two requirements:
- Form 1040NR: Jorge must file this form because he assigned the contract to the holding structure.
- FIRPTA withholding: The holding structure has a FIRPTA withholding requirement.
Both requirements are routinely ignored in practice. 🙂 But the technical requirements exist.
«The basic rule for taxation of dispositions of real estate.»
Section 897(a) contains the rule. Gain or loss is taxed when there is a
«disposition» of a «U.S. real property interest» by a «nonresident alien or foreign corporation.»
It is really more complicated than that. Section 897(a) says treat the gain or loss on that disposition «as if» it were income effectively connected with the conduct of a U.S. trade or business by that nonresident alien or foreign corporation transferor. More about that «as if» below.
«U.S. real property interest» is more than just land and buildings
A U.S. real property interest (abbreviated USRPI) includes more than just the land and buildings on it. A USRPI is:
- An «interest in real property» under IRC Section 897(c)(1)(A)(i).
- An interest other than solely as a creditor in a U.S. real property holding corporation (USRPHC) under IRC Section 897(c)(1)(A)(ii).
- A USRPHC is a domestic corporation owning a significant amount of real estate (balance sheet test) under IRC Section 897(c)(2).
«Interest in real property» includes a purchase contract
A nonresident visits the U.S. and falls under the spell of a real estate agent. Next thing you know, there is a contract to buy a beautiful house or condo, with the nonresident as the buyer.
That purchase contract is an «interest in real property.» Treasury Regulation Section 1.897-1(d)(2)(ii)(B) states:
«An option, contract, or right of first refusal to acquire any interest in real property (other than solely as a creditor) constitutes by itself an interest in real property other than solely as a creditor.»
So if the nonresident buyer and the current owner (seller) have a signed contract enforceable in court by either party, the buyer is the owner of a real property interest. The real estate is in the U.S., so it is a USRPI.
Oops, I want to use a holding structure
In my world, people sign the contract to buy real estate in the U.S. and make an earnest money deposit. Then they come to me for advice on ownership structures. We talk about estate tax, then set up some sort of structure to protect the nonresident buyer from U.S. estate tax.
Before closing, the individual (the named buyer) assigns their right to purchase the property (and the obligation to pay the purchase price) to the new holding structure. The seller consents.
This is a «disposition» of a USRPI by a «nonresident alien.»
Stop right there. We have a FIRPTA transaction defined by IRC Section 897(a), and a FIRPTA withholding requirement under IRC Section 1445(a).
The right under the real estate purchase contract is an interest in real estate. It is a USRPI. You are a nonresident alien. You disposed of the USRPI when you assigned all your rights and obligations under the contract to your new holding structure.
The assignment of the purchase contract fits perfectly within IRC Section 897(a)(1). Read the statute. You decide:
«For purposes of this title, the gain or loss of a nonresident alien individual or foreign corporation from the disposition of a USRPI shall be taken into account:
(A) in the case of a nonresident alien individual, under section 871(b)(1), or
(B) in the case of a foreign corporation, under section 882(a)(1),
as if the taxpayer were engaged in a trade or business within the United States during the taxable year and as if such gain or loss were effectively connected with such trade or business.»
But there is no gain or loss
Not exactly. Two issues arise:
- Form 1040NR filing requirement: Jorge must file this form, even with zero gross income, due to his engagement in a U.S. trade or business.
- FIRPTA withholding: The holding structure that acquired the contract has a FIRPTA withholding requirement, even if no payment is made.
Tax return filing requirement
Treasury Regulation Section 1.6012-1(b)(1)(i) states:
«Except as provided in subparagraph (2) of this paragraph, every nonresident alien individual (not treated as a resident under section 6013(g) or (h)) who is engaged in a trade or business in the United States at any time during the taxable year or who has income subject to tax under Subtitle A of the Code shall file a return on Form 1040NR. For this purpose, it is irrelevant whether gross income for the taxable year is less than the amount specified in section 6012(a) for filing a return.»
Do you understand? The mere fact of being engaged in a trade or business in the U.S. triggers a filing requirement for Form 1040NR for a nonresident alien. This is true even if there is no income. A small consolation: the last sentence of this Regulation makes preparing the return a bit easier. But the filing requirement remains.
Does IRC Section 897(a)(1) make the taxpayer «engaged in trade or business»?
Section 897(a)(1) uses the well-trodden «as if» language to define tax obligations. Usually, Congress uses «presumed,» but here it plainly states «as if.» Gain on disposition of a USRPI is treated «as if the taxpayer were engaged in a trade or business within the United States during the taxable year and as if such gain or loss were effectively connected with such trade or business.»
If you are «engaged in trade or business,» you must file a tax return
The mere fact of being engaged in a trade or business in the U.S. triggers a Form 1040NR filing obligation. Perhaps it is an abbreviated filing, but it exists. Treasury Regulation Section 1.6012-1(b)(1)(i) confirms it. And see the Form 1040NR Instructions.
