Office of Audit
ADDITIONAL CONTROLS ARE NEEDED TO HELP ENSURE THAT NONRESIDENT ALIEN INDIVIDUAL PROPERTY OWNERS COMPLY WITH TAX LAWS
Final Report issued on August 23, 2017
Highlights of Reference Number: 2017-30-048 to the Internal Revenue Service Commissioners for the Large Business and International Division and the Wage and Investment Division.
IMPACT ON TAXPAYERS
Nonresident alien individuals who own and derive rental income from U.S. residential real property (hereafter referred to as U.S. property) can reduce their tax liability by electing to treat rental income generated by those properties as effectively connected to a U.S. trade or business. Nonresident aliens who make this election can reduce their rental income by offsetting rental income with expenses pertaining to the rental activity. The IRS does not ensure that these taxpayers properly make the election before allowing these tax advantages. As a result, taxpayers who fail to comply with the laws receive the same tax benefit as those who do.
WHY TIGTA DID THE AUDIT
It is estimated that nonresident alien individuals’ investment in U.S. property increased from $34.8 billion during the 12-month period ending March 2013 to $43.5 billion during the 12-month period ending March 2016. This audit was initiated to evaluate the IRS’s efforts in identifying and addressing nonresident alien individuals who should be paying tax on rental income of U.S. property.
WHAT TIGTA FOUND
The IRS can improve controls to ensure that nonresident aliens are properly reporting rental income from U.S. property. TIGTA reviewed a random sample of 149 nonresident aliens who rented their U.S. property in Tax Year 2013. TIGTA found that 102 (68 percent) of them reduced their gross rental income when reporting their rental activity without complying with the statutory requirement of applying for this tax benefit by submitting an election statement. The IRS needs to improve compliance checks for ensuring that election statements are made. As a result, $1.78 million in gross rental income should have been subject to 30 percent tax withholding of $533,000 ($56.2 million in withholding when projected to the population).
The IRS also needs to improve tools for identifying nonresident aliens who are not reporting rental income from U.S. property they own. From our sample drawn from foreign property owners in five counties, TIGTA identified foreign property owners who appeared to have failed to report and pay tax on rental income they earned (at least 28 of 214 foreign property owners in our sample). When these exceptions are projected over the population reviewed in five selected areas, there is potentially $60.9 million in unreported rental income.
WHAT TIGTA RECOMMENDED
TIGTA recommended that the IRS:
· Revise Form 1040NR, U.S. Nonresident Alien Income Tax Return, for nonresident aliens to make an election under Internal Revenue Code Section 871(d) and revise processing procedures to ensure that the IRS records the election.
· Verify withholding credits claimed on Form 1040NR against information in the Foreign Investment in Real Property Tax Act Database and research the nonresident alien’s Master File account to determine if the U.S. property was rented and depreciated and, if so, verify calculation of the property’s cost basis used in a sale.
· Develop a compliance initiative addressing foreign property owners who do not report rental income generated by real property they own in the United States.
IRS management agreed with our recommendations regarding the revision to the 1040NR and the initiation of a compliance initiative but disagreed with our recommendation concerning Foreign Investment in Real Property Tax Act verification.
READ THE FULL REPORT
To view the report, including the scope, methodology, and full IRS response, go to:
Phone Number / 202-622-6500
E-mail Address / TIGTACommunications@tigta.treas.gov
Website / https://www.treasury.gov/tigta